FRM Part I · FRM Exam Part I · Trading Strategies
A long call butterfly is built with strikes 90, 100 and 110 on the same underlying and expiry, costing a net $3 to set up. Ignoring discounting, what are the two breakeven stock prices at expiration?
The breakevens are 93 and 107. On the way up the payoff equals the $3 cost at 90 plus 3, and on the way down the payoff of 110 minus the price equals 3 at 107. Profit exists only between those prices.
- A93 and 107Correct
- B90 and 110
- C97 and 103
- D93 and 110
Explanation
Lower breakeven: 90 + 3 = 93, where the payoff on the rising leg equals the cost. Upper breakeven: the payoff 110 - S equals 3, so S = 107. Maximum payoff is 10 at 100. Option 97 and 103 wrongly subtracts the cost from the middle strike.
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