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Straddle Example• Current stock price = $100•Purchase at-the-money call (strike = 100) for $2 •Purchase at-the-money...

Straddle Example•

Current stock price = $100•Purchase at-the-money call (strike = 100) for $2

•Purchase at-the-money put (strike = 100) for $3

•What is the total value of your option portfolio for different stock prices(e.g. $120 or $85?)

Expert Solution

Initial cost of the strategy = Premium paid for buying a call option and buying a put option

Given,Cost of Call @ 100 strike = 2 USD

Cost of Put @ 100 strike - 3 USD

Therefore, total cost is 5 USD.

The profit from the startegy will happen if the stock moves above 105 USD or moves below 95 USD.

Case 1 - When stock price @ 120 USD,

Pay off from the call option is Max (120-100, 0) , which is 20 USD

Pay off the Put options is Max (100-120,0), which is zero. The option is not exercised and remain worthless.

Total pay off from Call and Put is 20+0 = 20 USD

Net profit is computed by subtracting the initial cost of 5 USD from the total pay off = 20 - 5 = 15 USD.

Therefore total value of portfolio, when the stock price @ 120 usd is 15 USD.

Case 2 - When stock price @ 85 USD,

Pay off from the call option is Max (85 -100, 0) , which is 0 dollars. The option is not exercised and remain worthless.

Pay off the Put options is Max (100-85), which is 15 USD.

Total pay off from Call and Put is 15+0 = 15 USD

Net profit is computed by subtracting the initial cost of 5 USD from the total pay off = 15- 5 = 10USD.

Therefore total value of portfolio, when the stock price @ 85 usd is 10USD.

jeff jeffy answered 1 year ago

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