Question

Microsoft is currently trading at $26. You expect that prices will increase but not rise above $28 per share. Options on microsoft with strikes of $22.50, $25.00, $27.50, and $30 are available. What options portfolio would you construct from these options to incorporate your views?

Answer 1

Answer:

The answer is $27.5

As the answer should encompass between present trade value and expected trade value.

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Answer 2

Answer:

Microsoft is currently trading at $26. You expect that prices will increase but not rise above $28 per share. Options on Microsoft with strikes of $22.50, $25.00, $27.50, and $30 are available. The portfolio that was constructed from these options to incorporate our views was given below.

Explanation:

• You would create a bullish vertical spread by selling the call at a strike of 27.50 and buying the call at a strike of 25.00. This way you do not pay for the appreciation above 28, however, you collect any appreciation between 26 and 27.50.
• An alternative is to sell the 30 strike call instead of the 27.50 call. This is more expensive since the short 30-call brings in less premium that the short 27.50 call (put differently you are now also paying for the range from 28 to 30, which you do not believe will occur). But it builds in some error in the upper bound of the view on the upside.
• If the Microsoft's shares will fall but a fall below $22 is unlikely now the strategy we will use is a bearish vertical put spread would be used, constructed by purchasing the 25 strike put, and selling the 22.50 put. This will capture gains if the stock falls from its current price of 26 all the way to 22.50.

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