Q3 1) Option trading strategy (8 marks)

Jacob bought one call option and one put option on FFC Corp shares. These two options have the same exercise volume and expiration date, but have different exercise prices. Both options are European options. Information on the options can be found in the table below:

a). What is the maximum loss of this trading strategy? Is there a maximum profit? Explain. (4 marks)

b). What is the profit/loss of this trading strategy if share price of FFC Corp is $15 at maturity? (1 mark)

c). At what share price(s) will Jacob break even on this trading strategy at maturity? (2 marks)

d). What must be Jacobs expectation of the share price of FFC Corp at expiration, given his investment strategy? (maximum 2 sentences) (1 mark)

Q3 2) Futures (4 marks)

A 1-year futures contract on a non-dividend-paying share is currently traded at $27. The market price of the underlying share is $25. The risk-free rate is 3%.

a). What should the futures price be based on non-arbitrage spot-futures parity? (1 mark)

b). Construct an arbitrage trading strategy to exploit mispricing. In your answer, state the positions taken in each asset needed and explain why it is an arbitrage strategy. Support your explanation with relevant numbers. (3 marks)

Option Type Exercise Price Premium Call Put 30 25 $1.50 $2.50