It is October 12, 2016 and Apple shares are currently trading at $400. The market prices for January 21,
2017 maturity Apple options are as follow:
Strike Call Price Put Price Strike Call Price Put Price
$360 $57.88 $15.20 $410 $27.83 $35.10
$370 $51.00 $18.40 $420 $23.25 $40.50
$380 $44.70 $21.83 $430 $19.20 $46.55
$390 $38.50 $25.85 $440 $15.80 $58.10
$400 $33.00 $30.25 $450 $13.56 $66.81
You expect that, by January 2017 option expiration, Apple shares will be beaten down, most likely to around $360. In your mind, the stock would find strong support at around $360 level end the chances of the stock breaking down below that support is very slim. You wish to capitalize on this bearish scenario to the best possible extent, but the latest service outage of Blackberry may boost iPhone sales further, and as such, you want your maximum loss on the upside to be less than $5.00/shares. Based on your beliefs and risk preference, you would not mind making a bet that you could entail large losses if Apple slides down well below the $360 level by January 21, 2017.
a) Design a debit ratio spread strategy, using just two strikes, that Is most suitable given the specifics of your expectations and investment goal/risk preference. Clearly state your positions on each option. Also draw the profit diagram of the strategy. [HINT: spread strategies consist of the same-type options and ratio strategies have different loadings for each option in the strategy (such as strip and strap strategies). Think about a butterfly spread and Straddle]
b) What is the maximum loss on the upside? What is the maximum profit on the downside?
c) Find out the range of Apple share prices at option expiration time where you would have positive profit.