Assume that the stock of ABC, Inc., is currently trading for $21 and will either rise to $30 or fall to $18 in one year. Assume the risk-free rate for one year is 0 percent. You own a portfolio that consists of one call option and one put option. Both options have a strike price of $25, and both expire in one year. What is the value of your portfolio? (Do not round intermediate computations. Round final answer to one decimal place.)

Question

Quizplus · Accepted Answer

If the stock rises to $30, both the call and put options will expire worthless and your portfolio will be worth $0. If the stock falls to $18, the call option will expire worthless and the put option will be exercised, resulting in a payoff of $7 ($25 strike price - $18 stock price). Thus, the value of your portfolio is the present value of the expected payoff of the put option:
PV = $7 / (1 + 0%) = $7
Subtracting the initial cost of buying both options ($0.50 each, or $1 total) yields a portfolio value of $6. Therefore, the best choice is D.

Assume That the Stock of ABC, Inc