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 it is uncertain as to the direction. For example, a firm may be a rumored take over candiate. If the rumor is wrong, the stocks price could decline and make the put profitable. If the rumor is true and it does happen than the price of the stock may rise and the calls becomes profitable. There is also the poss. that the price of the stock could rise and than 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 stock 50 bucks
price of six month call at 50 bucks $5
price of six month put at 50 bucks $3.50
a. 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?