A straddle occurs when an investor purchases both a call option

| June 2, 2016

Question
A straddle occurs when an investor purchases both a call option and a put option. Such a strategy makes sense when the individual expects a major price movement but is uncertain as to the direction. For example, a firm may be a rumored takeover candidate. If the rumor is wrong, the stock’s price could decline and make the put profitable. If the rumor is correct and a takeover bid does occur, the price of the stock may rise and the call becomes profitable. There is also the possibility ( probably small, at best) that the price of the stock could rise and subsequently fall, so the investor earns a profit on both the call and the put. The following problem works through a straddle. Given the following

Price of the stock $ 50 Price of a six- month call at $ 50 5 Price of a six- month put at $ 50 3.50 the individual establishes a straddle ( i. e., buys one of each option).

What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 60?
b) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 40?

c) What is the profit ( loss) on the position if, at the expiration date of the options, the price of the stock is $ 50?

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