Several of your clients (including: Andrew Berry, Denis Haskew, Yan Tyler-Teys and Vidan Chen) trade technology stocks because they like the increased volatility in this sector. You advise them that they could setup a strap or strip position in order to make gains from large increases or decreases in stock prices. Another client of yours (Kate Simon Alexander) believes that IBEM will increase in value and she is interested in taking a long position in 250 strips (these blanks are left intentionally) using nine-month options with an exercise price of $160 on IBEM. Via Bloomberg you note that the current price of IBEM is $154 with volatility of 28% per annum. The risk free rate is 1% per annum with continuous compounding and the dividend yield is 3% per annum with continuous compounding.
a) Based on Kate’s expectation of future IBEM prices, would you advise Kate to take a long or short position in 250 straps or 250 strips?
b) Calculate the cost of the option strategy detailed in part a) for Kate.
c) Show Kate using a profit/loss table and graph what her potential profit/loss will be using this option strategy. In answering part c), please only show the profit/loss table and graph for 1 strip or strap (as determined by your answer to part a). In your graph label: the axes, maximum or minimum, and breakeven points. In addition, graph the strip/strap and the component option positions.
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d) In nine months the stock price has increased to $250 and Kate is ready to exercise her IBEM stock options. Calculate the total payoff and total profit/loss to Kate across all strips/straps