FRM Part I · FRM Exam Part I · Introduction to Derivatives
A European call and a European put on the same stock both have a strike of USD 60 and the same expiry. The call premium is USD 5 and the put premium is USD 4. An investor buys both (a straddle). Ignoring discounting, for which range of expiration stock prices does the investor make a net profit?
The investor profits when the stock ends below USD 51 or above USD 69. The straddle costs USD 9 in total premium, and the payoff equals the absolute distance from the USD 60 strike, so that distance must exceed USD 9.
- ABelow USD 51 or above USD 69Correct
- BBelow USD 55 or above USD 65
- CBelow USD 56 or above USD 64
- DBetween USD 51 and USD 69
Explanation
Total premium = 5 + 4 = 9. Payoff is |S - 60|, so profit requires |S - 60| > 9, meaning S < 51 or S > 69. Between 51 and 69 the investor loses. USD 56/64 uses only the put premium of 4 and call... incorrectly, and the inside range reverses the logic.
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