Option combinations Ms. Higden

Option combinations Ms. Higden has been offered yet another incentive scheme (see Section 20-2). She will receive a bonus of $500,000 if the stock price at the end of the year is $120 or more; otherwise she will receive nothing. (Don’t ask why anyone should want to offer such an arrangement. Maybe there’s some tax angle.)

a. Draw a position diagram illustrating the payoffs from such a scheme.

b. What combination of options would provide these payoffs? (Hint: You need to buy a large number of options with one exercise price and sell a similar number with a different exercise price.)

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