1. A trader buys a call option with a strike price of €45 and a put option with a strike price of €40. Both options have the same maturity. The call costs €3 and the put costs €4. Draw a diagram showing the variation of the trader’s profit with the asset price. Explain the purpose of this strategy
Position of Trader:
Long call option with strike price of €45 bought at €3
Long put option with strike price of €40 bought at €4
Total Premium paid = $7
The above strategy is know as long strangle.
| Spot price at Expiry | Payoff from call with X = 45 | Payoff from Put with X = 40 | Total Premium on call + Put | Payoff from strategy |
| 10 | 0 | 30 | -7 | 23 |
| 15 | 0 | 25 | -7 | 18 |
| 20 | 0 | 20 | -7 | 13 |
| 25 | 0 | 15 | -7 | 8 |
| 30 | 0 | 10 | -7 | 3 |
| 35 | 0 | 5 | -7 | -2 |
| 40 | 0 | 0 | -7 | -7 |
| 45 | 0 | 0 | -7 | -7 |
| 50 | 5 | 0 | -7 | -2 |
| 55 | 10 | 0 | -7 | 3 |
| 60 | 15 | 0 | -7 | 8 |
| 65 | 20 | 0 | -7 | 13 |
| 70 | 25 | 0 | -7 | 18 |
| 75 | 30 | 0 | -7 | 23 |
Purpose of taking Long Strangle position is to earn profit in case there is some event related to stock and heavy movements is expected in price of the stock on either side.
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