April 2009 q4

Would you please explain the payoff for the bear spread? How does the flat portion at the bottom occur? I tried drawing the long call and short call pay off separately and tired to find out what I'd get by adding them! But I got the flat top part, the slanting portion but the lower horizontal portion I just couldn't figure out!

Also in the part (iv) (a) would it not be 125?
Would the profit not be 100 X (ST - K -O)?
100 X (0.75-1.5-0.5)

 

Assuming we use put options with long Put with Strike K2 and Short Put with Strike K1 & k2>k1, Then ignoring Option premium, we get the following payoffs

+P(K2) -P(K1) Overall

S(T)>K2 0 0 0

K2>S(T)>K1 K2-S(T) 0 K2-S(T)

K1>S(T) K2-S(T) -K1+ S(T) K2-K1


0 & K2 - K1 are the flat portions of the pay off.

Assuming we use call options with long call with Strike K2 and Short call with Strike K1 & K2>K1, Then ignoring Option premium, we get the following payoffs

+C(K2) -C(K1) Overall

S(T)>K2 S(T) - K2 K1 - S(T) K1 - K2

K2>S(T)>K1 0 K1 - S(T) K1-S(T)

K1>S(T) 0 0 0

0 & K1 - K2 are the flat portions of the payoff.

 

Hi vikhan29!

thanks so much for taking the time to reply! But Im really not able to follow ur notation! WHy three 0's in the first line?...

Sorry! But I'd be glad if you could probably put it in words!

 

v.s;37102]Hi vikhan29!

thanks so much for taking the time to reply! But Im really not able to follow ur notation! WHy three 0's in the first line?...

Sorry! But I'd be glad if you could probably put it in words![/QUOTE]

I had created a payoff table but the formatting went haywire when I posted it.

Nevertheless first two 0s mean both the options - long and short - are out of money and third number (overall) is the sum of first two.

You can find these illustrations in Hull's book.

 

Thanks