Question

Momo, a fast-growing company, is going to make an earnings announcement three months from now. But you do not know whether it will be positive or negative (i.e., the stock price will go up or down). The current price of the stock is $50 per share. A three-month call will exercise price of $50 costs $5. A put with the same price and expiration date costs $3

a. what would be a simple options strategy to bet on the stock price volatility?

b. Construct a table that shows the payoff and profit from the options strategy.

c. For what range of stock prices would the options strategy lead to a loss?

Answer 1

a) A simple options strategy to bet on stock price volatility is to buy both the call and the put options on the stock (buying a straddle)

b) The table showing profit of call and put option along with total profit from the position is shown below

Stock price	Profit from Call	Profit from Put	TOTAL
St	max(St-50,0)-5	max(50-St,0)-3	PROFIT
35	-5	12	7
36	-5	11	6
37	-5	10	5
38	-5	9	4
39	-5	8	3
40	-5	7	2
41	-5	6	1
42	-5	5	0
43	-5	4	-1
44	-5	3	-2
45	-5	2	-3
46	-5	1	-4
47	-5	0	-5
48	-5	-1	-6
49	-5	-2	-7
50	-5	-3	-8
51	-4	-3	-7
52	-3	-3	-6
53	-2	-3	-5
54	-1	-3	-4
55	0	-3	-3
56	1	-3	-2
57	2	-3	-1
58	3	-3	0
59	4	-3	1
60	5	-3	2
61	6	-3	3
62	7	-3	4
63	8	-3	5
64	9	-3	6
65	10	-3	7

c) As can be seen from the table , the total profit is negative when the stock prices are between 42 and 58

The options strategy results in a loss from the range 42<St<58 i.e. when the prices are above 42 or below 58.