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FRM Part I · FRM Exam Part I · Trading Strategies

A long call butterfly uses European calls with strikes 90, 100 and 110 (long one 90, short two 100, long one 110). The net premium paid is $2.50. At expiration, what are the two breakeven stock prices?

The breakevens are 92.50 and 107.50. The butterfly's payoff equals the $2.50 cost at 90 + 2.50 on the way up and at 110 - 2.50 on the way down. The outer strikes 90 and 110 are where the payoff hits zero, not the breakeven points.

  1. A92.50 and 107.50Correct
  2. B90.00 and 110.00
  3. C97.50 and 102.50
  4. D92.50 and 110.00

Explanation

Lower breakeven: the payoff rises from zero at 90 with slope 1, so profit is zero when S - 90 = 2.50, S = 92.50. Upper side: the payoff falls from 10 at 100 to zero at 110, so payoff = 110 - S = 2.50 gives S = 107.50. Using the outer strikes ignores the premium paid.

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