Question

Suppose you buy a straddle on Zoom with a strike price of $134. The current premium on $134 call is $7.80; the current premium on a $134 put is $5.40.

a) Explain the payoff and profit if the stock price is $115 at expiration.

b) Explain the payoff and profit if the stock price is $155 at expiration.

c) What is/are the break-even stock price(s) for the strategy?

d) Why might you engage in such a strategy?

Answer 1

a) The pay off at stock price of $115 at expiration is :

= ($134 - $115)

= $19

b) The pay off when the stock price is $155 at expiration,

= ($155 - $134)

= $21

c) The total premium paid is : $7.8 + $5.4

= $13.2

So, the break - even stock prices are :

= Strike price of call + premium paid

= $134 + $13.2

=$147.2

The other stock price is :

= $134 - $13.2

= $120.8

This strategy can be bought when the investor wants to protect himself from both the upward and downward stock movements and this is also a low cost strategy as the premium paid is low and that is maximum loss an investor can suffer. The profit potential is unlimited as the stock price can increase upto infinity.