FRM Part I · FRM Exam Part I · Trading Strategies
A trader buys a strangle: a put with strike $40 for $1.50 and a call with strike $60 for $2.50, same expiry. What is the trader's maximum loss and the stock price range at expiry over which it occurs?
The maximum loss on a long strangle is the total premium paid, $4.00. It occurs whenever the stock finishes between the two strikes, $40 and $60, because both options then expire worthless. Losses are capped at the premium, not unlimited.
- A$4.00, for any stock price between $40 and $60Correct
- B$4.00, only if the stock price ends at $50
- C$2.50, for any stock price between $40 and $60
- DUnlimited, if the stock price ends above $60
Explanation
Net premium = 1.50 + 2.50 = $4.00. If the stock ends between the strikes, both options expire worthless, so the loss is the full $4.00 across the whole range. It is not only at $50, and the loss is capped at the premium.
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