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Kruka [31]
3 years ago
11

a trader creates a long butterfly spread from options with strike prices x, y, and z, where x < y < z, and y is exactly mi

dway between x and z. a total of 400 options are traded. the difference between x and y is $13. the difference in the prices of the options with strike prices of z and y is $5.03. the difference in the prices of the options with strike prices of y and x is $6.67. what is the maximum net gain (after the cost of the options is taken into account)
Business
1 answer:
Montano1993 [528]3 years ago
3 0

Answer:

<em>$1006 </em>

Explanation:

A long butterfly is created by following these steps

  •  Long 1 call option for strike X ( highest premium say C)
  • Short 2 call option for Strike Y (premium =C-6.67 )
  •  Long 1 call option for strike Z (premium = C-6.67 - 5.03 = C-11.70 where X<Y<Z

Here, Y-X = Z-Y =$11.70

<u>i) whenever the price at maturity goes below the price of x ( no call option is executed )</u>

payoff =  2*(C-6.67) -C-(C-11.7) = - 13.34 + 11.70 = - 1.64

<u>ii) when the price at maturity is between X and Y, only call with strike X is executed </u>

hence  payoff = -1.64 +(P-X) where P is the Price at maturity

p - x = y-x = 11.70

hence maximum payoff = - 1.64 +  11.70 = $10.06

<u>iii) When the price is between Y and Z , only call with strike X and Y are executed.</u>

hence, payoff = -1.64 + (P-X)  -2* (P-Y) = -1.64 +( 2Y - X - P) and this value decreases as P increases

the minimum payoff occurs when P=Z

So, maximum payoff = -1.64 + (Z-X) - 2*(Z-Y) = -1.64 + 23.4 - 2*11.7 = -$1.64

<u>iv) When the price at maturity is more than Z , all calls are executed</u>

hence, payoff = -1.64 +(P-X) -2* (P-Y) + (P-Z) = -1.64+(2Y-X-Z)

=  -1.64+(Y-X -(Z-Y)) = -1.64+(11.7 - 11.70)

= -$1.64  

 the maximum payoff occurs when P=Y

considering the  four options  traded the maximum payoff = $10.06

<em>Finally determine the maximum net gain when 400 options are traded</em>

<em>= 10.06 * 400 / 4 </em>

<em>= 10.06 * 100 =  $1006 </em>

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