Question 1

1. (20) One of the more complex options strategies is the so-called "iron condor" portfolio, using a combinations of long and short positions, call and put options, and four different strike prices. In this question we will consider what would motivate traders to construct such a portfolio and the structure of the payoffs that they receive from it. Suppose that stock in Hieroglyph Inc. is currently priced at S, = 150 per share, with prices of various options written on this stock given below. Strike | Call Price Put Price 120 35 5 140 20 10 160 10 20 180 5 35 (a) (10) Suppose that you are convinced that this stock is not as volatile as the market believes it to be, but are unsure of the direction of future price movements. Construct a suitable portfolio to match your beliefs, and plot the payoff diagram (you may assume a zero risk-free rate). (b) (10) Now suppose that, while you still believe that extreme price movements in either direction are unlikely, you wish to limit your downside risk just in case. Modify your portfolio to achieve this, and plot the payoff diagram