Straddles

Question 1

Which of the following create a straddle?

I	Short 1 ABC Jan 50 Call
Short 1 ABC Jan 50 Put
II	Short 1 ABC Apr 50 Call
Short 1 ABC Oct 50 Put
III	Short 1 ABC Jan 50 Call
Long 1 ABC Jan 50 Put
IV	Long 1 ABC Jan 50 Call
Long 1 ABC Jan 60 Put

A. I only
B. I and III
C. II and IV
D. III and IV

Answer 1

The best answer is A.

A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.

Question 2

Which of the following create a straddle?

I	Long 1 ABC Jan 50 Call
Long 1 ABC Jan 50 Put
II	Long 1 ABC Jan 50 Call
Short 1 ABC Jan 60 Put
III	Short 1 ABC Jan 50 Call
Short 1 ABC Jan 50 Put
IV	Short 1 ABC Jan 50 Call
Short 1 ABC Jan 60 Put

A. I and II
B. I and III
C. II and IV
D. III and IV

Answer 2

The best answer is B.

A straddle is the purchase of a call and a put; or the sale of a call and a put; on the same underlying security with the same strike price and expiration.

Question 3

Which of the following positions is a long straddle?

A. Long 1 ABC Jan 50 Call; Long 1 XYZ Jan 50 Put
B. Long 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Call
C. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 50 Put
D. Long 1 ABC Jan 50 Put; Short 1 ABC Jan 60 Put

Answer 3

The best answer is C.

A long straddle is created by purchasing a call and a put on the same stock, with the same strike price and expiration. Choice A has different stock positions. Choices B and D involve the purchase and sale of a call; or the purchase and sale of a put. These are spreads, which are covered in a later section.

Question 4

If the market price of the underlying security is greater than the strike price of the option contract, which of the following is likely to have a profit?

I The buyer of a straddle
II The seller of a straddle
III The seller of a call

A. I only
B. II only
C. III only
D. II and III

Answer 4

The best answer is A.

If the market price is greater than the strike price of the option contract, the buyer of an “at the money straddle” can exercise the call contract profitably (a long straddle consists of a call and a put on the same stock, with the same strike price and expiration). The put contract side of the straddle would expire “out the money.” If the market price stays the same, the buyer will lose, since both the call and the put that create the straddle would expire “at the money.” Concerning Choices II and III, both of these positions have a naked short call, which gives the writer unlimited upside risk. If the market price rises above the strike price, the calls go “in the money” and are exercised. This obligates the call writer to deliver stock at a fixed price; and this stock must now be purchased for delivery in the market at a higher price (and the market price can rise an unlimited amount!)

Question 5

A customer would buy a straddle because the customer:

A. is only bullish on the underlying security
B. is only bearish on the underlying security
C. believes that the market for the stock may be either bullish or bearish
D. wishes to generate some additional income from the underlying security during a period of market stability

Answer 5

The best answer is C.

A long straddle is the purchase of a call and the purchase of a put, on the same stock at the same strike price and expiration. If the market goes up, the long call goes “in the money” and the long put expires “out the money.” There is potentially unlimited profit on the long call. Conversely, if the market falls, the long put goes “in the money” and the long call expires “out the money.” The profit on the long put keeps increasing as the market falls, all the way to “0.” Thus, the position is profitable if the market either rises or falls. If the market stays the same and does not move, then both positions expire “at the money” and the premium paid is lost.

Question 6

A customer buys 1 ABC Jan 35 Call @ $4 and 1 ABC Jan 35 Put @ $2 when the market price of ABC is at $35.25. If ABC stock moves to $41 and stays there, the gain or loss at expiration is:

A. 0
B. $500 gain
C. $600 loss
D. $600 gain

Answer 6

The best answer is A.

If the stock moves to $41, the call goes “in the money” and will be exercised and the put expires “out the money.” When the call is exercised, the customer buys the stock at the strike price of $35, and sells it at the current market price of $41, for a 6 point gain. However, since 6 points was paid in combined premiums, the net result is no gain or loss. Thus, $41 is a breakeven point.

Question 7

On the same day, a customer buys 1 ABC Jan 50 Call @ $4 and 1 ABC Jan 50 Put @ $3, when the market price of ABC is $51. ABC rises to $57 and the customer lets the put expire and closes out the call at intrinsic value. The customer has:

A. a $700 gain
B. a $700 loss
C. a $1,400 gain
D. no gain or loss

Answer 7

The best answer is D.

The customer has bought a straddle.

Buy 1 ABC Jan 50 Call @ $4
Buy 1 ABC Jan 50 Put @ $3
$7 Debit

If the market rises to $57, the put expires “out the money.” The call is 7 points “in the money” and is closed at its intrinsic value. This results in a 7 point profit on the call. Since 7 points were paid in premiums, the customer breaks even.

Question 8

A customer buys 5 ABC Jan 30 Straddles for a total premium of $3,500. Just prior to expiration ABC stock closes at $21, and the customer closes the options positions at intrinsic value. The customer will have a:

A. $1,000 gain
B. $1,000 loss
C. $3,500 gain
D. $3,500 loss

Answer 8

The best answer is A.

A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Buys 5 ABC Jan 30 Calls
Buys 5 ABC Jan 30 Puts
$700 Debit x 5 contracts = $3,500 Debit

Note that the individual premiums are not given in the question, nor are they needed to answer the question.

If the market drops below $30, the call will expire “out the money” and the put goes “in the money.” Here the put is “in the money” (or has intrinsic value of) 9 points. This results in a 9 point profit on the put, if it is “closed” (sold) at intrinsic value. But, since 7 points were paid in premiums, the customer has a net gain of 2 points per share, or $200 per contract. Since there are 5 contracts, the total gain is $1,000.

Question 9

A customer buys 1 ABC Jan 40 Straddle for a total premium of $500. Just prior to expiration ABC stock closes at $31, and the customer closes the options positions at intrinsic value. The customer will have a:

A. $100 gain
B. $400 gain
C. $500 gain
D. $900 gain

Answer 9

The best answer is B.

A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Buys 1 ABC Jan 40 Call
Buys 1 ABC Jan 40 Put
$500 Debit

Note that the individual premiums are not given in the question, nor are they needed to answer the question.

If the market drops below $40, the call will expire “out the money” and the put goes “in the money.” Here the put is “in the money” (or has intrinsic value of) 9 points. This results in a 9 point profit on the put, if it is “closed” (sold) at intrinsic value. But, since 5 points were paid in premiums, the customer has a net gain of 4 points per share, or $400 per contract.

Question 10

A customer buys 1 ABC Jan 35 Call @ $3.50 and 1 ABC Jan 35 Put @ $.50 when the market price of ABC is at $34.75. ABC stock moves to $29 and stays there. Just prior to expiration, the positions are closed at intrinsic value. The gain or loss is:

A. 0
B. $200 gain
C. $600 loss
D. $600 gain

Answer 10

The best answer is B.

A long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Buys 1 ABC Jan 35 Call @ $3.50
Buys 1 ABC Jan 35 Put @ .50
$4.00 Debit

If the market drops below $35, the call will expire “out the money” and the put goes “in the money.” Here the put is “in the money” (or has intrinsic value of) 6 points. This results in a 6 point profit on the put, if it is “closed” (sold) at intrinsic value. But, since 4 points were paid in premiums, the customer has a net gain of 2 points per share, or $200 per contract.

Question 11

On the same day when the market price of ABC is $48, a customer:

Buys 1 ABC Jan 50 Call @ $3
Buys 1 ABC Jan 50 Put @ $5

The breakeven points are:

I $42
II $45
III $53
IV $58

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 11

The best answer is B.

The buyer of the straddle paid 8 points in premiums. The holder has to recover the 8 points to breakeven. This happens if the market rises by that amount; or falls by that amount. So, the customer will break even when the market is at $42 (for the Put side of the straddle, since the put is “in the money” by 8 points; the call expires “out the money”) and $58 (for the Call side of the straddle since the call is “in the money” by 8 points; the put expires “out the money”). To summarize, the breakeven formulas for a long straddle are:

Upside B/E = Call S/P + Combined Premium
Downside B/E = Put S/P - Combined Premium

Question 12

A customer buys 1 ABC Jul 65 Call @ $7 and buys 1 ABC Jul 65 Put @ $5 when the market price of ABC is $66. The breakeven points are:

A. $60 and $72
B. $58 and $70
C. $63 and $67
D. $53 and $77

Answer 12

The best answer is D.

Long straddles are profitable if the market either moves up or down. To breakeven, the total premium paid must be recovered by the market moving either up or down. To breakeven, the holder must recover the 12 point debit paid for the straddle. If the market rises, the call side goes “in the money” and can be exercised or closed for a profit. To recover the 12 point debit, the market must rise to $65 + $12 = $77. If the market falls, the put side of the straddle goes “in the money” and can be exercised or closed for a profit. To recover the 12 point debit, the market must fall to $65 - $12 = $53, To summarize, the breakeven formulas for a long straddle are:

Upside B/E = Call S/P + Combined Premium
Downside B/E = Put S/P - Combined Premium

Question 13

A customer buys 1 ABC Jul 75 Call @ $9 and buys 1 ABC Jul 75 Put @ $6 when the market price of ABC is $77. The maximum potential gain is:

A. $600
B. $900
C. $1,500
D. unlimited

Answer 13

The best answer is D.

The customer created a long straddle, which is the purchase of a call and a put on the same stock, with the same strike price and expiration. Since the customer has purchased a call, the maximum potential gain is unlimited as the market rises on the long call position (since it gives the customer the right to buy the stock at a fixed price in a rising market).

Question 14

A customer buys 1 ABC Jan 65 Call @ $7 and buys 1 ABC Jan 65 Put @ $2 when the market price of ABC = $64. The maximum potential loss is:

A. $200
B. $700
C. $900
D. unlimited

Answer 14

The best answer is C.

If the market stays at $65, both contracts expire “at the money.” The customer loses the $900 paid in premiums. This is the maximum potential loss.

Question 15

A customer buys 1 ABC Jan 30 Call @ $5 and buys 1 ABC Jan 30 Put @ $4 on the same day when the market price of ABC stock is $31. Assume that the market price rises to $38 and the call premium rises to $12, while the put premium falls to $1. The customer closes the positions. The customer has a:

A. $400 loss
B. $400 gain
C. $900 gain
D. $1,300 loss

Answer 15

The best answer is B.

The customer established two positions with a debit of $9 x 1 contract = $900 debit. When the market is at $38, the customer closes the call at $12 and closes the put at $1. Thus, the positions are closed at:

Short 1 ABC Jan 30 Call @ $12
Short 1 ABC Jan 30 Put @ $ 1
$13 credit = $1,300 credit

The customer closed for a credit of $1,300. Since the initial positions cost $900, the customer has a $400 gain.

Question 16

A customer buys 1 ABC Jan 50 Call @ $3 and buys 1 ABC Jan 50 Put @ $6 when the market price of ABC is $48. At which market prices is the position profitable?

I $44
II $41
III $40
IV $36

A. I and IV only
B. II and III only
C. II and IV only
D. III and IV only

Answer 16

The best answer is D.

A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $9 in premiums was paid, the market must move down by more than 9 points to profit on the put; or must move up by more than 9 points to profit on the call. Thus, the position is profitable either below $50 - $9 = $41; or above $50 + $9 = $59. Thus, the profitable prices here are $40 and $36. To summarize, the breakeven formulas for a long straddle are:

Upside B/E = Call S/P + Combined Premium
Downside B/E = Put S/P - Combined Premium

Question 17

A customer buys 1 ABC Jan 50 Call @ $4 and buys 1 ABC Jan 50 Put @ $6 when the market price of ABC is $49. At which market prices is the position profitable?

I $39
II $40
III $60
IV $61

A. I and IV only
B. II and III only
C. II and IV only
D. I, II, III, IV

Answer 17

The best answer is A.

A long straddle is the purchase of a call and the purchase of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised. If the market moves down, the put will be exercised. Since $10 in premiums was paid, the market must move down by more than 10 points to profit on the put; or must move up by more than 10 points to profit on the call. Thus, the position is profitable at either $39 or $61. Note that $40 and $60 are the breakeven points. To summarize, the breakeven formulas for a long straddle are:

Upside B/E = Call S/P + Combined Premium
Downside B/E = Put S/P - Combined Premium

Question 18

A customer who is short 1 ABC Jan 85 Put wishes to create a “short straddle.” The second option position that the customer must take is:

A. Long 1 ABC Jan 85 Call
B. Short 1 ABC Jan 90 Call
C. Short 1 ABC Jan 85 Call
D. Short 1 ABC Jan 85 Put

Answer 18

The best answer is C.

A short straddle is the sale of a call and a put on the same stock, with the same strike price and expiration. Choice C fits this definition. Choice B defines a combination, which is essentially the same as a straddle, except either the strike prices or expirations are different.

Question 19

A short straddle is profitable in a:

I rising market
II falling market
III stable market

A. I only
B. III only
C. II and III
D. I, II, III

Answer 19

The best answer is B.

A short straddle is the sale of a call and the sale of a put on the same stock at the same strike price and expiration. If the market moves up, the call will be exercised and the writer will lose. If the market moves down, the put will be exercised and the writer will lose. Thus, a short straddle is only profitable if the market does not move - thus it is profitable in a stable market.

Question 20

If the market price of the underlying security remains the same as the strike price of the option contract, which of the following will have a profit?

I The buyer of an “at the money” straddle
II The seller of an “at the money” straddle
III The seller of an “at the money” call

A. I only
B. II only
C. III only
D. II and III

Answer 20

The best answer is D.

If the market price remains the same as the strike price, then there is no reason for the holder of an option contract to exercise. The contracts will expire and the holder will lose the premium, while the writer will gain the premium. Sellers of contracts and straddles (the sale of a call and a put on the same stock with the same strike price and expiration) will profit. Holders of contracts and straddles will lose the premiums paid.

Question 21

If ABC is at a market price of $50, which of the following positions will be profitable?

A. Long 1 ABC Jan 60 Call @ $5; Long 1 ABC Jan 60 Put @ $5
B. Short 1 ABC Jan 60 Call @ $5; Short 1 ABC Jan 60 Put @ $5
C. Long 1 ABC Jan 50 Call @ $5; Long 1 ABC Jan 50 Put @ $5
D. Short 1 ABC Jan 50 Call @ $5; Short 1 ABC Jan 50 Put @ $5

Answer 21

The best answer is D.

Choice A is a long 60 straddle. If the market goes to $50, the put is 10 points “in the money,” while the call is 10 points “out the money” and will expire. The 10 point profit on the put exactly offsets the total 10 point premium paid - this is breakeven.

Choice B is a short 60 straddle. If the market goes to $50, the put is 10 points “in the money,” while the call is 10 points “out the money” and will expire. The 10 point loss on the put exactly offsets the total 10 point premium received - this is breakeven.

Choice C is a long 50 straddle. If the market stays at $50, both the call and the put expire “at the money” and the holder loses the premiums paid.

Choice D is a short 50 straddle. If the market stays at $50, both the call and the put expire “at the money” and the writer gains the premiums received.

Question 22

On the same day, a customer:

Sells 1 ABC Jan 50 Call @ $3
Sells 1 ABC Jan 50 Put @ $5

The market price of ABC at that time is $48. If the market rises to $60 and the call is exercised (the put expires out the money), the gain or loss is:

A. $200 loss
B. $700 loss
C. $800 gain
D. $1,000 gain

Answer 22

The best answer is A.

If the market rises to $60, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $50 on the short call. Since the price in the market is $60, the customer loses 10 points. After deducting the 8 points of premiums collected, the net loss is 2 points or $200.

Question 23

On the same day, a customer:

Sells 1 ABC Jan 65 Call @ $6
Sells 1 ABC Jan 65 Put @ $6

At that time, the market price of ABC is $65. If the market rises to $78 and the call is exercised (the put expires out the money), the gain or loss is:

A. $100 loss
B. $100 gain
C. $1,200 gain
D. $1,300 gain

Answer 23

The best answer is A.

If the market rises to $78, the put expires “out the money” and the call will be exercised. The writer is obligated to deliver the stock at $65 on the short call. Since the price in the market is $78, the customer loses 13 points. After deducting the 12 points of premiums collected, the net loss is 1 point or $100.

Question 24

A customer sells 5 ABC Jan 30 Straddles for a total premium of $3,500. At expiration, ABC closes at $21, and the customer is exercised. As a result, the customer will have a:

A. $1,000 gain
B. $1,000 loss
C. $3,500 gain
D. $3,500 loss

Answer 24

The best answer is B.
When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Sells 5 ABC Jan 30 Calls
Sells 5 ABC Jan 30 Puts
$700 Credit x 5 = $3,500 Credit

If the market stays exactly at $30, both positions expire and the customer would keep the $3,500 credit. In this case, the market declines to $21. The calls expire “out the money,” while the puts are 9 points “in the money” and will be exercised at a loss of 9 points = $900 per contract = $4,500 loss on 5 contracts. Since $3,500 was collected in premiums, the net loss is $1,000.

Question 25

A customer sells 1 ABC Jan 30 Straddle for a total premium of $500. At expiration, ABC closes at $21 and the customer is exercised. As a result, the customer will have a:

A. $100 gain
B. $400 gain
C. $400 loss
D. $900 gain

Answer 25

The best answer is C.

When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Sells 1 ABC Jan 30 Call
Sells 1 ABC Jan 30 Put
$500 Credit

If the market stays exactly at $30, both positions expire and the customer would gain the $500 credit. In this case, the market declines to $21. The call expires “out the money,” while the put is 9 points “in the money” and is exercised at a loss of 9 points = $900 loss. Since $500 was received in premiums, the net loss is $400.

Question 26

A customer shorts 1 ABC Jan 35 Straddle for a total premium of $350. At expiration, ABC closes at $29 and the customer is exercised. As a result, the customer will have a:

A. $250 loss
B. $600 gain
C. $600 loss
D. $950 gain

Answer 26

The best answer is A.

When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer:

Sells 1 ABC Jan 35 Call
Sells 1 ABC Jan 35 Put
$350 Credit

If the market stays exactly at $35, both positions expire and the customer would gain the $350 credit. In this case, the market declines to $29. The call expires “out the money,” while the put is 6 points “in the money” and will be exercised at a loss of 6 points = $600 loss. Since $350 was received in premiums, the net loss is $250.

Question 27

A customer sells 1 ABC Jan 50 Call @ $4 and sells 1 ABC Jan 50 Put @ $3 when the market price of ABC = $51. The breakeven points are:

A. $46 and $53
B. $47 and $54
C. $43 and $57
D. $45 and $55

Answer 27

The best answer is C.

The writer of the straddle collected 7 points in premiums. The writer loses the 7 points to breakeven if the market falls by that amount or rises by the amount. If the market falls by 7 points, the writer loses 7 points on the put and the call expires. The breakeven on the put side of the straddle is $50 - $7 = $43. If the market rises by 7 points, the writer loses 7 points on the call and the put expires. The breakeven on the call side of the straddle is $50 + $7 = $57. To summarize, the breakeven formulas for a short straddle are:

Upside B/E = Call Strike Price + Combined Premium
Downside B/E = Put Strike Price - Combined Premium

Question 28

A customer sells 1 ABC Jul 30 Call @ $1 and sells 1 ABC Jul 30 Put @ $3.50 when the market price of ABC is $29. The maximum potential gain is:

A. $450
B. $2,550
C. $3,450
D. unlimited

Answer 28

The best answer is A.

The customer created a short straddle.

Sell 1 ABC Jul 30 Call @ $1.00
Sell 1 ABC Jul 30 Put @ $3.50
$4.50 Credit

If the market stays at $30, both contracts expire “at the money” and the writer earns the credit of $450. This is the maximum gain.

Question 29

A customer sells 1 ABC Jul 35 Call @ $4 and sells 1 ABC Jul 35 Put @ $3 when the market price of ABC is $37. The maximum potential loss is:

A. $400
B. $700
C. $3,700
D. unlimited

Answer 29

The best answer is D.

Since one side of a short straddle is a short naked call, if the market rises there is unlimited risk.

Question 30

A customer sells 1 ABC Jan 70 Call @ $4 and sells 1 ABC Jan 70 Put @ $1 on the same day when the market price of ABC stock is $72. Assume that the market price falls to $66 and the call premium falls to $.50, while the put premium rises to $5.50. The customer closes the positions. The gain or loss is:

A. $100 gain
B. $100 loss
C. $500 gain
D. $500 loss

Answer 30

The best answer is B.

The customer established two positions with a credit of $5 x 1 contract = $500 credit. When the market is at $66, the customer closes the call at $.50 and closes the put at $5.50. Thus, the positions are closed at:

Buy 1 ABC Jan 70 Call @ $ .50
Buy 1 ABC Jan 70 Put @ $5.50
$6.00 debit = $600 debit

The customer closed for a debit of $600. Since the initial credit was $500, the customer has a $100 loss.

Question 31

If the price of the underlying security remains unchanged until expiration, which of the following options investors may have a profit?

I Buyer of an “at the money” Put
II Seller of an “at the money” Put
III Buyer of a Straddle
IV Seller of a Straddle

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 31

The best answer is D.

If the market price remains the same at expiration, “at the money” options contracts will expire. This means that the writer of the contract will earn the premium and the holder will lose the premium.

Since a long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration, the buyer of an “at the money” straddle will lose the premiums paid if the stock price remains unchanged because both positions will expire. On the other hand, the writer of that straddle, the sale of a call and a put on the same stock, will earn the premiums.

Question 32

Which TWO choices are “combinations”?

I Long 1 ABC Jan 50 Call; Short 1 ABC Jan 60 Call
II Long 1 ABC Jan 60 Put; Short 1 ABC Jan 50 Put
III Long 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put
IV Short 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Put

A. I and II
B. III and IV
C. I and IV
D. II and III

Answer 32

The best answer is B.

A “straddle” is the purchase of a call and put; or the sale of a call and put; with the same strike prices and expirations. A “combination” is the same as a straddle, except that the strike prices and/or expirations are different.

Question 33

When the market price of XYZ stock is $44 per share, which of the following choices would create a “strangle”?

A. Short 1 XYZ Jan 40 Put; Short 1 XYZ Jan 50 Call
B. Long 1 XYZ Jan 50 Put; Long 1 XYZ Jan 40 Call
C. Long 1 XYZ Jan 50 Call; Long 1 XYZ Jan 50 Put
D. Short 1 XYZ Jan 40 Call; Short 1 XYZ Jan 40 Put

Answer 33

The best answer is A.

A “strangle” is a specific variation of a combination, where both contracts are “out the money.” Choice C is a long straddle; Choice D is a short straddle. Straddles have the same strike price and expiration. Combinations have different strike prices and/or expirations.
A long strangle is the purchase of an “out the money” call and an “out the money” put. The “idea” behind the strategy is to profit from a volatile market, just like a long straddle. Because both contracts are “out the money,” the premium cost will be lower. However, the market must move more sharply (either up or down) in order for the position to be profitable. Choice B is not a long strangle because both positions are “in the money.”

A short strangle is the sale of an “out the money” call and an “out the money” put. The “idea” behind the strategy is to profit from a stable market, just like a short straddle. Because both contracts are “out the money,” the premiums collected will be lower. However, the market must move more sharply (either up or down) in order for the position to become unprofitable. Choice A is a short strangle because both positions are “out the money.”

Question 34

When the market price of ABC stock is $54 per share, which of the following choices would create a “strangle”?

A. Short 1 ABC Jan 50 Call; Short 1 ABC Jan 50 Put
B. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put
C. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 50 Put
D. Short 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Put

Answer 34

The best answer is D.

A “strangle” is a specific variation of a combination, where both contracts are “out the money.” Choice A is a short straddle; Choice C is a long straddle. Straddles have the same strike price and expiration. Combinations have different strike prices and/or expirations.
A long strangle is the purchase of an “out the money” call and an “out the money” put. The “idea” behind the strategy is to profit from a volatile market, just like a long straddle. Because both contracts are “out the money,” the premium cost will be lower. However, the market must move more sharply (either up or down) in order for the position to be profitable. In Choice B, the 50 call is in the money by $4 (market = $54) and the 60 put is in the money by $6 (market = $54), so while this is a combination, this is not a strangle.

A short strangle is the sale of an “out the money” call and an “out the money” put. The “idea” behind the strategy is to profit from a stable market, just like a short straddle. Because both contracts are “out the money,” the premiums collected will be lower. However, the market must move more sharply (either up or down) in order for the position to become unprofitable. In Choice D, the 60 call is out the money by $6 (market = $54) and the 50 put is out the money by $4 (market = $54), so this is a short strangle.

Question 35

Which of the following positions creates a “strangle” if the market price of ABC stock is $52 per share?

I Buy 1 ABC Jan 55 Call
II Buy 1 ABC Jan 50 Call
III Buy 1 ABC Jan 55 Put
IV Buy 1 ABC Jan 50 Put

A. I and II
B. III and IV
C. I and III
D. I and IV

Answer 35

The best answer is D.

A “strangle” is a specific variation of a combination, where both contracts are “out the money.” A long strangle is the purchase of an “out the money” call and an “out the money” put. Only Choice D fits this definition.

Buy 1 ABC Jan 55 Call
Buy 1 ABC Jan 50 Put

This would be done when the market price is between $50 and $55. Both contracts are “out the money” and the premiums paid would be lower than if a long straddle was purchased. To profit, the price must move up sharply above $55 by at least the amount of premiums paid; or must move down sharply below $50 by at least the amount of premiums paid. This is a volatility strategy, similar to a long straddle.

Question 36

A customer buys 1 ABC Jul 55 Call @ $2 and 1 ABC Jul 60 Put @ $5 on the same day. Just prior to expiration, the stock is trading at $59 and the customer closes the positions at intrinsic value. The customer has a net loss of:

A. $50
B. $100
C. $200
D. $700

Answer 36

The best answer is C.

The customer has purchased a long combination, for combined premiums of $700. When the stock is at $59, the long 60 put is 1 point “in the money,” resulting in a 1 point gain to the holder while the long 55 call is 4 points “in the money,” resulting in a 4 point gain to the holder. $700 paid in premiums minus a $500 profit = $200 loss.