Question

Suppose the effective annual interest rate is 9% and Freeman Company’s stock currently trades for $91...

Suppose the effective annual interest rate is 9% and Freeman Company’s stock currently trades for $91 per share. Suppose the premium for a 1-year $85-strike call option on the stock is $22.14, and the premium for a $85-strike put is $9.12. What is the profit earned on a long $85-strike straddle if Freeman’s stock is worth $87.55 when the options expire? (You may assume the stock pays no dividends over the next year.)

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Answer #1

Long Straddle means buying one call option and one put option for the same stock

Exercise price = $85

Premium paid for Call = $22.14

Premium paid for Put = $9.12

Total premium paid = $31.26

Interest lost for 1 year on premium paid = $31.26*9% = $2.8134

Price on Expiry = $87.55

Call buyer will exercise

Profit on Call = $87.55-$85 = $2.55

Put Buyer will not exercise, he can sell the stock at higher price in the market

Profit/Loss = 0

Net Profit from Straddle = $2.55 - $31.26 - $2.8134

=-$31.5234

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