Question

An investor buys a strangle on a JEDI stock by buying one call option with an exercise price of $20 for $1 and buying one put option with an exercise price of $18 for $3. (above relates to the questions below) (please show workings)

1. If JEDI’s expiration date stock price is $15, the investor’s profit is: (a) -$1 (b) $1 (c) $5 (d) -$7. 84.

2. If JEDI’s expiration date stock price is $20, the investor’s profit is: (a) $4 (b) -$2 (c) -$4 (d) $2. 85.

3. If JEDI’s expiration date stock price is $25, the investor’s profit is: (a) $7 (b) -$9 (c) -$3 (d) $1.

Answer 1

1. If the exercise price is $15, the investor's profit is :

Premium paid is : $1 + $3

= $4

As the stock price is $15, the put option will be exercised and the call option will expire worthless , so the profit made is :

= $18 - $15 - $4

= -$1

So, the correct option is option A.

2. If the exercise price is $20,

The call option will be exercised and the pay off  is 0, the net profit or loss is the amount of premium paid , so the loss is $4. ( $3 + $1)

= -$4

So, the correct option is option C.

3. If the stock price is $25,

The profit is : $25 - $20 - $4

= $1

The correct option is option D.