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

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In this portfolio, the investor is long one share of the stock and short two call options with a strike price of $60. This means that if the stock price goes above $60, the investor will have to sell two shares of the stock at $60 each, which gives a total of $120. The investor also buys one call option with a strike price of $120. If the stock price goes above $120, the investor can exercise the call option and buy one share of the stock at $120, and sell it at the higher market price. This gives a profit that is unlimited, because there is no upper limit to the stock price. The payoff diagram shows this as an upward-sloping line that goes to infinity on the right side. Note that the zero-interest bonds and the put option from choice A and the call option from choice C do not contribute to this payoff diagram.

Combining Options: Suppose You Are Creating a Portfolio That Consists