Question: Suppose the DJIA stands at 11,200. You want to set up a long straddle by purchasing 100 calls and an equal number of puts on the index, both of which expire in three months and have a strike of 112. The put price is listed at $1.65 and the call sells for $2.65.
a. What will it cost you to set up the straddle, and how much profit (or loss) do you stand to make if the market falls by 750 points by the expiration dates on the options? What if it goes up by 750 points by expiration? What if it stays at 11,200?
b. Repeat part a, but this time assume that you set up a short straddle by selling/ writing 100 July 112 puts and calls.
c. What do you think of the use of option straddles as an investment strategy? What are the risks, and what are the rewards?