FRM Part I · FRM Exam Part I · Trading Strategies
A trader buys a strangle: a put with strike $40 for $2 and a call with strike $50 for $3, both expiring on the same date. Ignoring discounting, what are the break-even stock prices at expiry?
The break-even prices are $35 and $55. The strangle costs $5 in total, so the stock must fall to $35 (put strike minus $5) or rise to $55 (call strike plus $5) before the position profits at expiry.
- A$35 and $55Correct
- B$38 and $52
- C$37 and $53
- D$40 and $50
Explanation
Total premium is $2 + $3 = $5. The lower break-even is the put strike less the premium: 40 - 5 = $35. The upper break-even is the call strike plus the premium: 50 + 5 = $55. Subtracting only the put premium and adding only the call premium gives $38 and $52, which is wrong because total cost applies to both sides.
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