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Yuan and Irina, who currently do not have a position in XYZ shares, expect that the price of XYZ share will increase in the next several months. The current XYZ share price is $45. Consequently, Irina buys 100 shares of stock XYZ and also buys a European put option on 100 shares of XYZ. Yuan buys a European call option on 100 shares of XYZ. The call and put options exercise prices are $45 (per share) and their premiums are $3 (per share). Each option has 3 months to expiration.
Suppose that the riskless interest rate is zero and that XYZ does not pay dividends.
a) Under what circumstances will Yuan exercise her option? Under what circumstances will Yuan make a profit?
b) Under what circumstances will Irina exercise her option? Under what circumstances will Irina make a profit?
c) Calculate the initial cash flow, and the maximum profit and losses and the break-even stock price on the options' expiration day for each investor.
d) Be aware of leverage: Suppose that both of them suffer the maximum loss. What are the percentage losses of each of them? Now, suppose that each of them invests $4,800 in their strategies. Calculate the maximum dollar losses and profits for each of them.
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