Question

1. A long straddle is an option strategy in which the investor buys a call option and a put option with the same strike price and the same expiration date. If the strike is $40/share and the premiums for the call and the put are $4/share and $3/share respectively. Draw the profit loss diagram for the long straddle strategy.

2. Repeat problem 1 for a short straddle (i.e. write a call and write a put).

Answer 1

Pay Off Table			Strategy - Long Straddle
	Strike Price	Premium	Maturity Pay Off
			30	35	40	45	50
Buy Call option	40	-4	0	0	0	5	10
Buy Put option	40	-3	10	5	0	0	0
Pay Off		-7	10	5	0	5	10
Net Pay off =	Maturity Pay off + Premium		3	-2	-7	-2	3
Pay Off Table			Strategy - Short Straddle
	Strike Price	Premium	Maturity Pay Off
			30	35	40	45	50
Write Call option	40	4	0	0	0	-5	-10
Write Put option	40	3	-10	-5	0	0	0
Pay Off		7	-10	-5	0	-5	-10
Net Pay off =	Maturity Pay off + Premium		-3	2	7	2	-3