The current stock price of Alcoa is $68 and the stock does not pay dividends. Yo
ID: 2738637 • Letter: T
Question
The current stock price of Alcoa is $68 and the stock does not pay dividends. You think in the near future there will be a dramatic movement in stock price depends on the result of a test for new drug. However the direction of the price movement is not clear, so you decide to establish a straddle strategy using at the money options with 1 month to expiration to take advantage of it. Both put and call at the money options have a premium of $5. 1 Month later, the test is postponed, as a result the stock price drops to $65. What is your profit or loss using your strategy?
700 profit
1000 profit
300 profit
1000 loss
700 loss
300 loss
A.700 profit
B.1000 profit
C.300 profit
D.1000 loss
E.700 loss
F.300 loss
Explanation / Answer
In this Straddle strategy, either direct of the stock the strategy holder will gain. In the present case,. Price drops to $65 from $68 making a $3 change. Now, Cost of both call and put are $10. Therefore, the difference is $7 ($10-$3) multiplied by 100 units (say) resulting in $700 profit.
Therefore, option A is correct with a profit of $700.
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