Question

Suppose XYZ stock is trading at $40 per share. An options trader enters a long straddle by buying a JUL 40 put for $200 and a JUL 40 call for $200. a) How much is the total investment the trader put into the straddle?b) What’s maximum loss the trader may have?c) If the stock in July trades at $30, what’s the profit on this trade?

Answer 1

a) How much is the total investment the trader put into the straddle?

A straddle strategy can be used to exploit the market condition in any direction where one call option and one put option of a stock with same strike price and same expiry date are purchased.

Total cost of straddle = Call price +Put price = $200 + $200 = $400

Therefore, the total investment the trader put into the straddle is $400

b) What’s maximum loss the trader may have?

The loss is limited to the cost of straddle, therefore maximum loss the trader may have is $400

c) If the stock in July trades at $30, what’s the profit on this trade?

If the stock in July trades at $30, then call option will expire worth less

And Straddle will profit only by put option (Number of shares in one contract is generally 100); therefore,

Profit = Number of shares in one contract *(strike price – stock price) - (Put price + call price)

= 100 *($40 - $30) - $400 = 100 * $10 - $400 = $1000 - $400 = $600