Avalon Corporation has beeb developing a new product for the past 5 years and th
ID: 2735458 • Letter: A
Question
Avalon Corporation has beeb developing a new product for the past 5 years and the product is coming out next month. It is not clear whether the product will succeed or fail, however you believe the success or failure of the product will have a very dramatic impact on the price of the company. What would be a simple options strategy using a put and a call to exploit your conviction about the stock price's future movement?
Buy a straddle
Buy a call.
Write a covered call.
Buy a put.
A.Buy a straddle
B.Buy a call.
C.Write a covered call.
D.Buy a put.
Explanation / Answer
Straddle is a strategy which involves buying or selling both the call option and put option on the same stock with both options having same expiry date and same exercise price.
The inherent assumption is while the buy is confident that the price of a particulart stock may move up or down significantly from the exercise price, seller is conservative and feels that the stock price is not going to vary significantly and would move in a narrow range on either side of the exercise price.
Therefore, option A is correct.
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