The price of a stock is currently $50. The price of a one year European call option on the stock with a price of $60 is $7 and the price of a one year European put option on the stock with a strike price of $40 is $6.

Q1: Suppose that an investor buys 100 shares of stock, shorts 100 call options, and buys 100 put options. Construct a table showing the investor’s profit (not payoff) as a function of the stock price at expiration.

Hints: To answer Q1, construct a column in Excel of stock prices ranging from $1 to $100 in increments of $1. Then use the next 3 columns to calculate the stock, put, call profits (one column for each position). Pay attention to whether the investor is taking a long or a short position of the option. Then add all the profits from these three positions (stock, put, call). Finally, use Excel to graph the portfolio profit (y axis) as a function of stock price (x axis). Specifically, use scatter plot in Excel. If you don’t know how, then type “scatterplot” in Excel help and follow the instruction. Your profit for long put option should look similar to Figure 9.2 in page 208 and the profit for short call should look

similar to Figure 9.3.

Q2: The set of actions in Q1 is called a “collar” strategy. Under what scenario will an investor use this collar strategy?

Q3: Suppose now that the investor buys 100 stocks, shorts 200 call options, and buys 200 put options. Construct a table showing the investor’s profit or loss as a function of the stock price at

expiration. Graph the portfolio profit as a function of stock price. The total profit should look like a zigzag (down/up/down) pattern.

Q4: What are the differences between A: (exchange traded) call options and B: warrants/employee stock options/convertibles?

Q5: Does exercising an inthemoney option always result in a positive profit?