A trader is bearish on a particular stock trading at $50. He is risk-averse, and wants to know before-hand his maximum loss. He also wants greater leverage than simply owning the stock. He expects the stock to move below $45.46 or not move at all, or even rise in the next 30 days. However, a drop to only $47.50 would prove disastrous for a trade he wants to implement. Given these expectations, the trader selects the $47.50 put option strike price to buy two puts which are trading for $0.44 each. The trader also sells one at-the money call with a strike price of $50.00 at a premium of $1.34.
i) Graph the profits from this trading strategy and comment.
ii) Explain what happens to the trader’s profits in the event of a big positive exogenous shock. What trade in options can the trader make in order to protect his position from such a shock?