Q4. PQ Inc is expected to announce its quarterly earnings in two weeks. PQ’s stocks are...

Q4. PQ Inc is expected to announce its quarterly earnings in two weeks. PQ’s stocks are currently trading at $43. You are an investor with knowledge of options and would like to take advantage of your expertise. What options strategy would you use around the earnings announcement to make profit? Outline the payoffs of your strategy.

Expert Solution

Q4: I am holding the stock of PQ Inc, i expect that the stock price might move in either direction as a result of the earning announcement in the PQ stock. If the earnings announcement is actually good and the stock is expected to rise as a result of the announcement. The trader can buy a call option on the stock at a particular strike price and then benefit from the increase in the stock price. Now, as i am skilled in options, i would like to protect myself from the downside risks in this stock as well, so i would purchase a put option as well on the same stock at the same strike price .The premium is paid to buy both the call and put options . This strategy is called the long straddle strategy. So, the investor would benefit if the stock moves in either direction post the earning announcement. This strategy is adopted when the trader is sure that the stock is going to show volatility but is not sure about the direction in which the volatility will take place.

So, the payoff from this strategy is :

The maximum loss = net premium paid on both the options.

The upper break even point is : Strike price + premium paid

The lower break even point is : Strike price - premium paid

The maximum profit from this strategy is unlimited. There is no limit to the upside profit potential in this strategy.

The profit obtained can be the difference between the stock price and the strike price - premium paid/ difference between the strike price and the stock price - premium paid.

jeff jeffy answered 1 year ago

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