Question

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

Answer 1

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.