Question

A call option with a strike price of $30 costs $1.5. A put option with a strike price of $25 costs $2.5. Explain how a strangle can be created from these two options. What is the pattern of profits from the strangle?

Answer 1

Strangle involves buying an out-of-the-money call and an out-of-the-money put option.
Total cost of strategy here will be $ 1.5 + $ 2.5 = $ 4
The pattern of profits is as follows:

Stock Price	Profit	Remarks
St < 25	( 25 - St ) -4	put will be exercised here & call is not exercised
25 < St < 30	- 4	both options will be worthless here
St > 30	( St - 30 ) - 4	call will be exercised here & put is not exercised

St means stock price.