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Consider a short straddle constructed from options on 3M stock which have an expiration date of...

Consider a short straddle constructed from options on 3M stock which have an expiration date of June 21, 2019 (the third Friday in June). The following table displays the only possible prices of 3M stock on June 21, as well as the payoffs accruing to someone who holds a short straddle on the stock:

Stock price $80 $90 $100 $110 $120
Gain from short straddle -$10 $0 $10 $0 -$10

A short straddle is created using two options. For each option in the short straddle above, indicate whether it is a put or a call, whether it is bought or sold, and what its strike price is. What is the maximum possible loss on this short straddle? What is the maximum possible loss on a real short straddle?

Explain your answer to all of the above questions

Solutions

Expert Solution

Short Straddle : A short straddle is an options strategy comprised of selling both a call option and a put option with the same strike price and expiration date. It is used when the trader believes the underlying asset will not move significantly higher or lower over the lives of the options contracts. The maximum profit is the amount of premium collected by writing the options. The potential loss can be unlimited, so it is typically a strategy for more advanced traders.

(1) It is Put and Call both sold with same strike price.

(2) Strike Price is $100.

Explanation : Profit at $100 strike is $10 which is option premium.In short straddle Put and call option of strike price @ $100 and received premium of $10. If price down to $90 then Put option buyer exercise the option and loss of $10 which is equal to option premium $10 so loss '0' (ZERO) and if price $80 then loss $20 and premium adjust $10 so loss reduce to $10.If price $110 then loss $10 which is equal to premium so net loss '0' (ZERO) and if price $120 then loss $20 and premium adjust $10 so loss reduce to $10.

(3) Maximum loss in this short straddle is $10 pe short straddle.

(4) Unlimited loss on a real short straddle.

jeff jeffy answered 1 year ago
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