A long strangle is created by buying a slightly out of the money put and a...

A long strangle is created by buying a slightly out of the money put and a slightly out of the money call with the same expiration date.

The market price of MSFT is $184.00.

The June 5 $195.00 calls have a premium of $1.70

The June 5 $175.00 calls have a premium of $3.70

a) What is the most an investor can lose on this position?

b) What does the price of MSFT need to be for the investor to break even?

Solutions

Expert Solution

Since the investor is long the strangle he will buy call option at exercise price of $195 and put option at exercise price of $175.

Premium on call option = $1.70
Premium on put option = $3.70

Total Premium paid = Premium on call option + Premium on put option
                                       = $1.70 + $3.70
                                       = $5.40

a) The maximum an investor can lose on this position will be the total premium paid i.e $5.40.
b) For breakeven the price should be,
     1) Exercise price of call option + Total Premium Paid = 195 + 5.40 = $ 200.40
     2) Exercise price of put option – Total Premium Paid = 175 – 5.40 = $ 169.60

ASSUMPTION : Since it is a strangle which involves buying out of the money call and out of the money put option, we assume options on June 5 having exercise price of $175 and premium $3.70 are put options instead of call options. The question have been solved considering it as put option only.

jeff jeffy answered 1 year ago

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