Question

You buy one call and one put with a strike price of $60 for both.  The call premium is $5 and the put premium is $6. What is the maximum loss from this strategy? [Using positive number for profit, and negative number for loss]

Answer 1

Strike price = X = $60, Call premium = c = $5 and Put premium = p = $6

If an investor buys call and put option with same strike price and same expiration then it is called as long straddle. In this question one buys one call option and one put with same strike price of $60, hence one has used long straddle as strategy

Profit = Payoff call option + Payoff put option - c - p = Max(0,S-X) + Max(0,X-S) - c - p

For all spot prices above strike price of $60, put option will be out of money with zero payoff and call option will generate positive payoff as it will be in the the money

For all spot prices below strike price of $60, call option will be out of money with zero payoff and put option will generate positive payoff as it will be in the money

For Spot price = Strike price. both call and put options will be at the money and both will have a payoff of $0

Since at spot price = strike price payoff is the lowest i.e. equal to zero, this will the be spot price for maximum loss. Maximum loss will be equal to sum of premiums of both the options.

Maximum loss of strategy = - c - p = -5 - 6 = -11

Hence maximum loss = -$11