Question

AstraZeneca plc (AZN) stock was trading at $45 in AUG and the following options prices are available: SEPT 40 put - $1.50 SEPT 50 call - $1 Consider a short strangle using AZN by selling one SEPT 40 put and one SEPT 50 call. Answer the following questions. A) What is the maximum profit you would expect from the strangle? B) What are the two break-even prices for AZN on expiration? C) What is the maximum loss you might experience from the strangle? D) The stock price declined to $39 on the expiration. What is the amount of profit or loss from the short strangle?

Answer 1

The short strangle also known as sell strangle is a strategy that involve the simultaneous selling of a slightly out-of-the-money put and a slightly out-of-the-money call of the same underlying stock and expiration date.

A)

Maximum profit expected = Premium received on selling call option + Premium received on selling put option = $1.5 + $ 1 = $2.5

B)

Upper Break even Point = Strike Price of Short Call + Net Premium Received = 50 + 2.5 = $52.5

Lower Break even Point = Strike Price of Short Put - Net Premium Received = 40 - 2.5 = $37.5

C)

Maximum loss than can be experienced from a short strangle strategy is unlimited

Large losses for the short strangle can be experienced when the underlying stock price makes a strong move either upwards or downwards at expiration

Loss = Price of Underlying - Strike Price of Short Call - Net Premium Received OR Strike Price of Short Put - Price of Underlying - Net Premium Received

D)

If the stock price declined to $39

Amount of Profit or loss = Price of underlying - Strike price of short put + Net premium received = $39 - $40 + $2.5 = $1.5

Therefore profit from short strangle if price of underlying is $39 = $1.5