Question

On December 21, 2020, you purchased 100 shares of ABC company at $11 per share. You plan to sell your shares on December 21, 2021 and are concerned about  downside risk. A put option on ABC stock with an exercise price (K) of $40 is currently priced (P) at $2 per share. Also, two call options on ABC stock with exercise prices (K) of $40 and $65 are priced (C) at $2.5 and $1.50 per share, respectively. All options expire on December 21, 2021.  What will be net profit/loss per share on a short straddle (not long straddle) if the stock price is $40 per share?

Answer 1

Short straddle means spelling of both a call option and put option of a same strike price.

It will sell the call option and put option of $40 at $2.5 and $2 respectively.

Gain on underlying shares= 100*(40-11)= $2900

Gain on expiration of put option= 100*2= $200

Gain on expiration of call option= 100*2.5= $250

the buyer of the call and put option would not exercise their rights because the call is expiring at the money and the put is also expiring at the money hence the seller of the straddle will gain through premium of both the option.

Total gains= (2900+250+200)= $3350