FRM Part I · FRM Exam Part I · Trading Strategies
A trader buys a European call with strike USD 50 for USD 3 and a European put with strike USD 50 for USD 2, both expiring in three months on the same stock. Ignoring discounting and transaction costs, what are the break-even stock prices at expiry?
The break-evens are USD 45 and USD 55. The straddle costs USD 5 in total premium, so the stock must finish USD 5 above the USD 50 strike for the call or USD 5 below it for the put to recover the cost.
- AUSD 45 and USD 55Correct
- BUSD 47 and USD 53
- CUSD 48 and USD 52
- DUSD 50 only
Explanation
Total premium is 3 + 2 = USD 5. The upper break-even is 50 + 5 = 55, where the call payoff of 5 covers the cost. The lower break-even is 50 - 5 = 45, where the put payoff of 5 covers the cost. Using only one option's premium would give wrong levels like 47 and 53.
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