Combining options: Suppose you are creating a portfolio that consists of zero-interest bonds, stock from a single company, and call and put options on the stock. Holding which of the following combination of securities will give the payoff shown in the following diagram?

Question

Quizplus · Accepted Answer

The payoff diagram shows a butterfly spread, which is created by combining a long call option at a lower strike price with two short call options at higher and lower strike prices, and a long put option at a higher strike price with two short put options at higher and lower strike prices. This can be achieved by selecting option B, where one call option with a $60 strike price is bought and one call option with an $80 strike price is sold short, and one put option with a $60 strike price is bought and one put option with a $40 strike price is sold short.

Combining Options: Suppose You Are Creating a Portfolio That Consists