Question

Three Finance majors have differing opinions about AAPL stock, which currently trades
at $300/share. Finance student 1 is very bullish and decides to purchase
shares of AAPL on margin. Student 2 feels the opposite and uses margin to sell short the same
number of shares of AAPL. Student 3 isn’t sure but feels AAPL will be volatile over the next year
and buys an ATM straddle. One year from today, AAPL trades at exactly $300/share. Which
student(s), if any, will see a negative ROI on their investment strategy, under normal
assumptions of transaction costs.

Student 2

All 3 students

None of the Students

Students 1 and 2

Students 2 and 3

Student 3

Student 1

Students 1 and 3

Answer 1

Solution:-

The ROI is calculated as net income divided by amount invested. The net income is calculated by taking gross returns and adjusting it for transaction expenses such as brokerage, exchange fee, etc.

The gross return of the apple stock is zero as the stock price was $300 per share before and it stayed at exactly $300 one year later.

ROIs of first and second student:-

The first two students made no gross profit or loss on their investments but would have incurred transaction costs which would result in a negative net income and thus negative ROIs.

ROI for third student:
An At-the-money Straddle is a strategy where an investor buys equal number of call and put options with same maturities and the strike price equal to the current stock price.

The strategy is beneficial in situations where there is a lot of volatility in stock prices. In the given situation, the third student paid premiums on both call options and put options but since the stock prices at the end of the year were equal to strike prices of the options, the options expired being worthless. The student made loss equal to the premiums paid as well as transaction costs.

Therefore, the third student made negative ROI as well.

Conclusion:

Based on above, all the three students had negative ROIs and the correct option is the first option 'All 3 students'