Question

7. What option strategy would be best if you believe there is a good chance for either large gains or large losses in the underlying stock over the next 6 months? Justify your answer.

Answer 1

When investor is expecting a huge movement in prices of the shares either up or down, He can employee straddle strategy. In this strategy equal number of call and put options are bought at same strike price with same maturity. If market moves up, call option will give profit and if market moves down put option will give profit

Table showing payoff

Price at exiry	Profit/loss on call option with strike price 50$ Permim = 5$	Profit/loss on put option with strike price 50$ Permim = 5$	Net profit
30	-5	15	10
31	-5	14	9
32	-5	13	8
33	-5	12	7
34	-5	11	6
35	-5	10	5
36	-5	9	4
37	-5	8	3
38	-5	7	2
39	-5	6	1
40	-5	5	0
41	-5	4	-1
42	-5	3	-2
43	-5	2	-3
44	-5	1	-4
45	-5	0	-5
46	-5	-1	-6
47	-5	-2	-7
48	-5	-3	-8
49	-5	-4	-9
50	-5	-5	-10
51	-4	-5	-9
52	-3	-5	-8
53	-2	-5	-7
54	-1	-5	-6
55	0	-5	-5
56	1	-5	-4
57	2	-5	-3
58	3	-5	-2
59	4	-5	-1
60	5	-5	0
61	6	-5	1
62	7	-5	2
63	8	-5	3
64	9	-5	4
65	10	-5	5
66	11	-5	6
67	12	-5	7
68	13	-5	8
69	14	-5	9
70	15	-5	10