Module 3 - Homework I
For all the problems in this assignment, use the following data on option prices for Pineapple Inc.
25        22 1/2    Jul            29   3 7/8          77   1 1/8
25        25        Jul            131  2 3/8          73   2 1/4
25        27 1/2    Jul            45   1 3/4          14   3 3/4
1. Covered Call

A covered call position is one in which the owner of a stock sells a call option on the same stock. Construct a payoff diagram for a covered call position for Pineapple Inc., assuming that the call is written at a strike price of $ 25. What are the risks and rewards of the covered call position? In what way would the risks/rewards change if you wrote a call at a strike of $ 27.5 instead of $ 25?

2. A Bear Spread

A bear spread is a trade in which a call option at strike X1 is bought and another call at a lower strike price X2 is sold. Construct a payoff diagram and explain the risks and rewards from a bear spread created from call options of Pineapple Inc., with strike prices of $ 22.5 and $ 27.5. In particular, discuss why the name "bear spread" is appropriate for this position.

How would the position payoff and the risks/rewards change if you used strikes of $ 22.5 and $ 25 instead? Under what circumstances (i.e, your posture towards Pineapple Inc.) might you prefer this position over the first one?

3. Butterfly Spread

This position is created by buying a call with a high strike price X1, buying another call with a relatively low strike X2 and selling two calls at an intermediate strike X3.

Construct a payoff diagram and describe the risks/rewards from setting up a butterfly spread from the three call options of Pineapple Inc. given above.

4. Strangle

This position is created by buying a call with a high strike price and a put at a lower strike price. Construct a payoff diagram and explain the risks/rewards from setting up a strangle from calls of Pineapple Inc. at strikes of $ 22.5 and $ 27.5. How do the risks/rewards from the strangle compare to those from a straddle @ strike of $ 25? Under what circumstances might one position be preferred to another?