An investor purchases a stock for $38 and a put for $0.50 with a strike price of $35. The investor sells a call for $0.50 with a strike price of $40. What is the maximum profit and loss for this position

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Business

Karli Franklin

15 January, 08:28

An investor purchases a stock for $38 and a put for $0.50 with a strike price of $35. The investor sells a call for $0.50 with a strike price of $40. What is the maximum profit and loss for this position

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Sanaa Harper · Answer 1

Maximum profit = $2 while

Maximum loss = - $3.

Explanation:

This is seen to be a zero cost collar and is calculation is as shown below;

Maximum profit = $40 - $38 = $2

Maximum loss = $35 - $38 = - $3.

The option position described is a zero cost collar. This is so because the premium paid for the protective put is offset by the premium received for writing a covered call while the collar here will put a band around the prospective returns by limiting the upside and downside of position. The upside will be limited by the strike price on the covered call which is $40, while the downside will be limited by the strike price of the put being $35.