Question

Question 16 A call option on the ASX 200 index with a strike of 5000 costs 200 (in index points). A put option on the index with strike of 5000 costs 150 (in index points). An investor wishes to buy a straddle using these options. a) Is the investor betting on the direction of the ASX index or its volatility? b) Explain how to create a straddle from these two options. Construct the net payoff table (1 mark) and draw the net payoff diagram for the straddle. a c) Assume the investor also combines the long straddle in part (b) with a long position on (4 marks) ro the SPI futures. What is the investor now betting on? SO (2 marks) 2= 7 marks) (1 4

Answer 1

a) Volatility: Straddle being a combination of call and put options, the investor is betting on volatility of Index

b) Straddle will be created by buying a call and put option at the same strike of 5000. The total cost of the straddle is 200 +150 = 350 index points

Index	Call Payoff	Put Payoff	Cost	Payoff
4200	800	0	350	450
4300	700	0	350	350
4400	600	0	350	250
4500	500	0	350	150
4600	400	0	350	50
4700	300	0	350	-50
4800	200	0	350	-150
4900	100	0	350	-250
5000	0	0	350	-350
5100	0	100	350	-250
5200	0	200	350	-150
5300	0	300	350	-50
5400	0	400	350	50
5500	0	500	350	150
5600	0	600	350	250
5700	0	700	350	350
5800	0	800	350	450

Payoff 4650 Index value 0 5350 5000

c) Investor is betting on the volatility as well as the increase in the value of Index.