In mid-May, there are two outstanding call option contracts available on the stock of ARB Co.:
Call #
Exercise Price
Expiration Date
Market Price
1
$50
19-Aug
$8.40
2
60
19-Aug
3.34
a. Assuming that you form a portfolio consisting of one Call #1 held long and two Calls #2 held short, complete the following table showing your intermediate steps. In calculating net profit, be sure to include the net initial cost of the options.
Price of ARB Stock at Expiration
Profit on Call #1 Position
Profit on Call #2 Position
Net Profit on Total Position
$40
—
—
—
45
—
—
—
50
—
—
—
55
—
—
—
60
—
—
—
65
—
—
—
70
—
—
—
75
—
—
—
b. Graph the net profit relationship in Part a, using stock price on the horizontal axis. What is (are) the breakeven stock price(s)? What is the point of maximum profit?
c. Under what market conditions will this strategy (which is known as a call ratio spread) generally make sense? Does the holder of this position have limited or unlimited liability?
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