Question

In: Finance

An investor is very confident that a stock will change significantly over the next few months;...

An investor is very confident that a stock will change significantly over the next few months; however, the direction of the price changes is unknown. Which pair of strategies is most likely to produce a profit if the stock price moves as expected?

I. Short butterfly spread

2. Bearish calendar spread

3. Long at-the-money straddle

4. Short strangle

A. 2 and 3

b. 2 and 4

C. 1 and 4

D. 1 and 3

Solutions

Expert Solution

Option D - Short butterfly spread & Long at-the-money straddle

Reason :-

A short butterfly spread with calls or puts is the strategy of choice when the forecast is for a stock price move outside the range of the highest and lowest strike prices.A short butterfly spread with calls or puts realizes its maximum profit if the stock price is above the highest strike or below the lowest strike on the expiration date. The forecast, therefore, must be for "high volatility," i.e., a price move outside the range of the strike prices of the butterfly.

A long straddle is an options strategy where the trader purchases both a long call and a long put on the same underlying asset with the same expiration date and strike price. The strike price is at-the-money or as close to it as possible.The forecast, therefore, must be for "high volatility," i.e., a price move outside the range of the strike prices of the straddle.If the stock goes up more than Strike price then call will make profit & if stock goes down then Put will make profit.


Related Solutions

How are household patterns anticipated to change over the next few years? What will be the...
How are household patterns anticipated to change over the next few years? What will be the impact of such changes on the Palestinian demand for different goods?
A stock is currently at $30. Over each of the next two three-months periods, the stock...
A stock is currently at $30. Over each of the next two three-months periods, the stock may move up to a factor 1.20 or down by a factor of 0.80 each period. A call option with strike price of $32 and maturity of six months is available. The current risk-free rate is 4% per year. Is the call option in the money, at money, or out of money. Explain. Find the value of this call option using the binomial tree...
You own a US company with borrowings from Switzerland. Over the next few months, your loan...
You own a US company with borrowings from Switzerland. Over the next few months, your loan repayment of CHF 50 million is due. Given the foreign exchange market movements, you would like to minimise the impact on your cash outflow. Based on the following data, devise a suitable strategy. Evaluate your chosen strategy against suitable alternatives for a range of expected future spot rates. Spot rate = 0.9888 CHF/USD 3 month forward rate = 3 month future rate = 0.9796...
An investor considers a stock that expects to have high growth over the next 5 years...
An investor considers a stock that expects to have high growth over the next 5 years and then a constant growth rate thereafter. As a result, the stock follows the pattern of a two-stage valuation model. If the investor instead uses a constant growth model using the constant growth rate that the company expects after year 5, he/she:
The current price of a non-dividend-paying stock is $30. Over the next six months it is...
The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $28. Assume the risk-free rate is 10% per annum (continuously compounded). What, to the nearest cent, is the price of an American put option with a strike price of $33? (Your answer should be in the unit of dollar, but without the dollar sign. For example, if your answer is $1.02, just enter 1.02.)
The current price of a non-dividend-paying stock is $30. Over the next six months it is...
The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $28. Assume the risk-free rate is 10% per annum. What, to the nearest cent, is the price of a European put option with a strike price of $33? (Your answer should be in the unit of dollar, but without the dollar sign. For example, if your answer is $1.02, just enter 1.02.)
The current price of a non-dividend-paying stock is $50. Over the next six months it is...
The current price of a non-dividend-paying stock is $50. Over the next six months it is expected to rise to $60 or fall to $48. Assume the risk-free rate is zero. An investor sells call options with a strike price of $55. What is the value of each call option according to the one-step binomial model? Please enter your answer as a number rounded to two decimal places (with no dollar sign).
The current price of a non-dividend-paying stock is $30. Over the next three months it is...
The current price of a non-dividend-paying stock is $30. Over the next three months it is expected to rise to $36 or fall to $26. Assume that the risk-free rate is 10% per annum (continuously compounded). What is the risk-neutral probability of the stock price moving up to $36? a) .40 b) .48 c) .50 d) .60
Giant acquired all of Small’s common stock on January 1, 2011. Over the next few years,...
Giant acquired all of Small’s common stock on January 1, 2011. Over the next few years, Giant applied the equity method to the recording of this investment. At the date of the original acquisition, $102,500 of the fair-value price was attributed to undervalued land while $53,000 was assigned to equipment having a 10-year life. The remaining $69,500 unallocated portion of the acquisition-date excess fair value over book value was viewed as goodwill.         Following are individual financial statements for the year...
Puny acquired all of Small's common stock on January 1,2013. Over the next few years, Puny...
Puny acquired all of Small's common stock on January 1,2013. Over the next few years, Puny applied the equity method to the recording of this investment. At the date of the original acquisition, $90,000 of the fair-value price was attributed to undevalued land while $50,000 was assigned to equipment having a 10-year remaining life. The $60,000 unallocated portion of the acquisition-date excess fair value over book value was viewed as goodwill. Following are individual financial statements for the year ending...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT