Question

Which 1-yr option strategy will give the highest expected net profit if you are confident that the underlying stock price will be less volatile over the next year than what the market prices reflect? (Please explain)

• A. Long put and long call
• B. Short put and short call
• C. Long put and short call
• D. Short put and long cal

Answer 1

The correct answer is

B) Short put and Short call

The investors expectation is that there would be very less volatility so the appropriate strategy would be creating a short straddle. Short straddle is when you write a call option and you write a put option and you will benefit if the prices remain with in the range. By writing the call you receive the premium and by writing the put you also receive the premium so here the gain is from the premium received because of the low volatility.

The other options are not correct, we would be taking long call and long put if we would be expecting high volatility but the investor is expecting low volatility. The other strategies are not dependent on volatility