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FRM Part I · FRM Exam Part I · Options Markets

A trader buys a straddle on a non-dividend stock by purchasing one call and one put, both with strike $80, paying $4.50 for the call and $3.50 for the put. Ignoring discounting, which range of stock prices at expiration results in a net loss for the trader?

The trader loses money if the stock ends between $72 and $88. The total premium paid is $8, so the break-evens are the strike plus or minus $8. Outside this range the straddle's payoff exceeds the premium and yields a profit.

  1. ABetween $72 and $88Correct
  2. BBetween $76.50 and $83.50
  3. CBelow $72 or above $88
  4. DBetween $80 and $88

Explanation

Total premium = 4.50 + 3.50 = $8. Break-even points are 80 - 8 = $72 and 80 + 8 = $88. Between these prices the payoff is less than $8, so the trader loses. The $76.50-$83.50 range wrongly uses only half the premium. Below $72 or above $88 is the profit region.

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