Question

You wrote a call and put Lockheed Martin with a strike of $150, the premiums were $8 and $6 respectively. What is the name of this strategy? Draw and label the graphs for both options and the strategy.

Answer #1

As we have written both the options, we have sold them and as the strike price 150 each then it is a short straddle strategy. Had the strike price been different, then it would have been a short strangle all other things remaining the same.

Following is the graph of the short straddle:

To plot the above graph we have taken the following data points as shown in the below table:

Short Call | Short Put | ||||

Spot price | Exercise price | Premium | Spot price | Exercise price | Premium |

150 | 8 | 150 | 6 | ||

Payoff | Profit | Payoff | Profit | ||

140 | 0 | 8 | 140 | -10 | -4 |

141 | 0 | 8 | 141 | -9 | -3 |

142 | 0 | 8 | 142 | -8 | -2 |

143 | 0 | 8 | 143 | -7 | -1 |

144 | 0 | 8 | 144 | -6 | 0 |

145 | 0 | 8 | 145 | -5 | 1 |

146 | 0 | 8 | 146 | -4 | 2 |

147 | 0 | 8 | 147 | -3 | 3 |

148 | 0 | 8 | 148 | -2 | 4 |

149 | 0 | 8 | 149 | -1 | 5 |

150 | 0 | 8 | 150 | 0 | 6 |

151 | -1 | 7 | 151 | 0 | 6 |

152 | -2 | 6 | 152 | 0 | 6 |

153 | -3 | 5 | 153 | 0 | 6 |

154 | -4 | 4 | 154 | 0 | 6 |

155 | -5 | 3 | 155 | 0 | 6 |

156 | -6 | 2 | 156 | 0 | 6 |

157 | -7 | 1 | 157 | 0 | 6 |

158 | -8 | 0 | 158 | 0 | 6 |

159 | -9 | -1 | 159 | 0 | 6 |

160 | -10 | -2 | 160 | 0 | 6 |

161 | -11 | -3 | 161 | 0 | 6 |

Let us understand the situation:

- Writing both options means we are short on both them
- This implies that we have received the premium amount of them
- Now lets look at the short call option:
- exercise price is 150 and premium receive is 8
- Call option gives the buyer the right to buy the underlying at the strike price
- This will only happen when the current price or the spot price in the market is higher than the exercise price, so that the buyer is able to buy the underlying at the exercise price and sell it in the open market at a higher price
- when this situation arises, the seller of the option has no option but to fulfill the contract
- So his loss is the difference between the spot price and the exercise price as shown in the payoff column
- but some of this loss is recovered from the premium received which is the final profit/loss
- When the spot price is lower than the exercise price, the call option wont be exercised and the entire premium received is a profit to the seller while his payoff is 0

- Now lets look at the short put option:
- exercise price is 150 and premium received is 6
- Put option gives the buyer the right to sell the underlying at the strike price
- This will only happen when the current price or the spot price in the market is lower than the exercise price, so that the buyer is able to sell the underlying at the exercise price and reduce his loss
- when this situation arises, the seller of the option has no option but to fulfill the contract
- So his loss is the difference between the spot price and the exercise price as shown in the payoff column
- but some of this loss is recovered from the premium received which is the final profit/loss
- When the spot price is higher than the exercise price, the put option wont be exercised and the entire premium received is a profit to the seller while his payoff is 0

- Above graph is showing the payoffs of each option being plotted

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