Finance 465 project 8: option strategy reverse engineering

Project 8: Option Strategy Reverse Engineering



In this project you will reverse engineer an option strategy. You will determine what financial instruments to utilize in order to create the option strategy.


The client informs you that he wants to buy a stock which costs $10 per share right now. He would like a portfolio payoff diagram as seen below. You are asked to combine this stock, call options (purchase or write), put options (purchase or write) and create the portfolio payoff diagram below (the absolute values of all the slopes are 1 in the diagram):


Strategy Payoff Diagram















           0                   20            30      40                              60      70               80                  100         S



Specifically, you can use


1. The stock (cost of the stock: $10)

2. Call and Put options on the stock with Exercise price: $20 (cost of call: $15, put: $2)

3. Call and Put options on the stock with Exercise price: $30 (cost of call: $10, put: $3)

4. Call and Put options on the stock with Exercise price: $40 (cost of call: $5, put: $4)

5. Call and Put options on the stock with Exercise price: $60 (cost of call: $4, put: $5)

6. Call and Put options on the stock with Exercise price: $70 (cost of call: $3, put: $10)

7. Call and Put options on the stock with Exercise price: $80 (cost of call: $2, put: $12)

8. Call and Put options on the stock with Exercise price: $100 (cost of call: $1, put: $15)


Answer the following questions in your report:


1. How do you obtain the payoff diagram above? In other words, what portfolio combination leads to the payoff diagram below?


2. What is the cost of this portfolio?


3. Using Excel, create the payoff diagram of this option strategy using the stock prices on the x-axis and calculating the total payoff at those stock prices (Create the graph by using those stock prices in the first column, and the payoffs in the next column. Use Scatter Plot –> Scatter with Straight lines).




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