Question

A. Explain what you would adopt as a share trading strategy if you believed that markets tend to over-react to new information. What do you believe are the limitations to actually applying this trading strategy?

Answer 1

Straddle strategy involves buying same number of put and call option having same strike price and maturity. This strategy will benefit investor if market moves significantly either on one side. If market is expected to over react on any news it means it has high volatility and thus straddle strategy is best. On other side it has only one limiteation and that is the premium that is to be paid to acquire the call and put options. If premium are very high break even of the strategy will also be high and thus it will be difficult to make profit even if there if movement in the market