Question

On December 21, 2020, you purchased 100 shares of ABC company at $11 per share. You plan to sell your shares on December 21, 2021 and are concerned about downside risk. A put option on ABC stock with an exercise price (K) of $40 is currently priced (P) at $2 per share. Also, two call options on ABC stock with exercise prices (K) of $40 and $65 are priced (C) at $2.5 and $1.50 per share, respectively. All options expire on December 21, 2021. What will be net profit/loss per share on a long straddle if the stock price is $10 per share?

Answer 1

A long Straddle involves buying both put and call on the stock at same exercise price and expiration date. Therefore we will buy call and put option at exercise price of $40.
Premium Paid on Call Option = $2.50
Premium Paid on Put Option = $2.00

Total cost of strategy = Premium Paid on Call Option + Premium Paid on Put Option
                   = $2.50 + $2.00
                   = $4.50

Share Price today = 10
Since share price today is less than exercise price call Option lapses out of the money and payoff = 0
Payoff from put option = Exercise Price of Call Option - Stock Price Today
                   = $40 - $10
                   = $30

Profit per share on a long straddle = Payoff from Call Option + Payoff from Put Option – Total cost of strategy
                   = 0 + $30 - $4.50
                   = $25.50