Suppose a stock has historical volatility of 15% and market is pricing options on that stock based on historical volatility. You expect that volatility of that stock to increase 25% in the near future. This increased volatility could lead to substantial increase or decrease in price of the stock that is currently trading at $35. You want to profit from increased volatility of this stock by using options in any combinations before price changes to a new value.
a. State how you would formulate an option strategy (number of call/put/stocks, long/short) to take advantage of this situation.
b. Draw profit diagram of your strategy along with the profits of each component. You do not need to calculate the exact amount of profit for this question. Clearly label each line.