Problem 14-05

The common stock of Company XYZ is currently trading at a price of $44. Both a put and a call option are available for XYZ stock, each having an exercise price of $42 and an expiration date in exactly six months. The current market prices for the put and call are $1.45 and $3.85, respectively. The risk-free holding period return for the next six months is 3%, which corresponds to an 6% annual rate.

1. For each possible stock price in the following sequence, calculate the expiration date payoffs and profits (net of the initial purchase price) for the following positions: (1) buy one XYZ call option, and (2) short one XYZ call option (assume the call is uncovered):

   20, 25, 30, 35, 40, 45, 50, 55, 60

   Do not round intermediate calculations. Round your answers to the nearest cent. If your answer is zero, enter "0". Use a minus sign to enter negative values, if any.

   1. Buy one XYZ call option.

      Expiration Date XYZ Stock Price	Expiration Date Derivative Payoff		Initial Derivative Premium		Net Profit
      $20	$		$		$
      $25	$		$		$
      $30	$		$		$
      $35	$		$		$
      $40	$		$		$
      $45	$		$		$
      $50	$		$		$
      $55	$		$		$
      $60	$		$		$

      Choose the correct graph of this payoff relationship, using net profit on the vertical axis and potential expiration date stock price on the horizontal axis. Calculate the price at which the position will break even (i.e., produce a net profit of zero).

      The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 28 .

      A.
      B.
      C.
      D.

      The breakeven point: $

   2. Short one XYZ call option

      Expiration Date XYZ Stock Price	Expiration Date Derivative Payoff		Initial Derivative Premium		Net Profit
      $20	$		$		$
      $25	$		$		$
      $30	$		$		$
      $35	$		$		$
      $40	$		$		$
      $45	$		$		$
      $50	$		$		$
      $55	$		$		$
      $60	$		$		$

      Choose the correct graph of this payoff relationship, using net profit on the vertical axis and potential expiration date stock price on the horizontal axis. Calculate the price at which this position will break even (i.e., produce a net profit of zero).

      The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 57 .

      A.
      B.
      C.
      D.

      The breakeven point: $

2. Using the same potential stock prices as in Part a, calculate the expiration date payoffs and profits (net of the initial purchase price) for the following positions: (1) buy one XYZ put option, and (2) short one XYZ put option. Do not round intermediate calculations. Round your answers to the nearest cent. If your answer is zero, enter "0". Use a minus sign to enter negative values, if any.

   1. Buy one XYZ put option.

      Expiration Date XYZ Stock Price	Expiration Date Derivative Payoff		Initial Derivative Premium		Net Profit
      $20	$		$		$
      $25	$		$		$
      $30	$		$		$
      $35	$		$		$
      $40	$		$		$
      $45	$		$		$
      $50	$		$		$
      $55	$		$		$
      $60	$		$		$

      Choose the correct graph of this relationship.

      The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 86 .

      A.
      B.
      C.
      D.

      The breakeven point: $

   2. Short one XYZ put option.

      Expiration Date XYZ Stock Price	Expiration Date Derivative Payoff		Initial Derivative Premium		Net Profit
      $20	$		$		$
      $25	$		$		$
      $30	$		$		$
      $35	$		$		$
      $40	$		$		$
      $45	$		$		$
      $50	$		$		$
      $55	$		$		$
      $60	$		$		$

      Choose the correct graph of this relationship.

      The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 115 .

      A.
      B.
      C.
      D.

      The breakeven point: $

3. Determine whether the $2.40 difference in the market prices between the call and put options is consistent with the put-call parity relationship for European-style contracts. Do not round intermediate calculations. Round your answer to the nearest cent.

   Difference between the call and put prices according to the put-call parity: $

   Put-call parity -Select-holdsdoes not holdItem 118 for this European-style contract.