FINANCE 2000- Consider a “long strangle” constructed from options which have an expiration

| March 14, 2016

Question 3 Introduction

Consider a “long strangle” constructed from options which have an expiration date of September 15, 2016 (the third Friday in September). The following table displays the possible prices of Boeing stock on September 15, as well as the payoffs accruing to someone who holds a long strangle on Boeing stock:
Probability 0.2 0.3 0.2 0.2 0.1
Stock price $80 $90 $100 $110 $120
Gain from long strangle $15 $5 $0 $10 $20

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3a.What will it cost an investor to buy a long strangle today?

3b.A long strangle is created using two options. For each option in the strangle above, indicate whether it is a put or a call, whether it is bought or sold, and calculate what its strike price is. Explain your answer.

3c.Why would someone buy a long strangle? Explain carefully.

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4a.Briefly describe what a futures contract is.

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4b.What is the difference between initial margin and maintenance margin on a futures contract?

4c.One futures contract on orange juice is equal to 15,000 lbs. of juice. Recently, the contract was trading at around $ 1.50/lb. If the initial margin for an orange juice contract is $1,890, approximately what is the leverage an investor enjoys by trading this commodity?

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