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FRM Part I · FRM Exam Part I · Options Markets

A trader buys one 40-strike call, sells two 50-strike calls, and buys one 60-strike call, all same expiry and underlying. Which statement best describes the position at expiry?

The position is a long call butterfly: it earns its maximum when the stock finishes at 50, and the loss is capped at the net premium paid if the stock ends below 40 or above 60. It is a bet on low volatility.

  1. AMaximum profit occurs if the stock ends at 50 and the loss is limited to the net premium paid if the stock ends below 40 or above 60Correct
  2. BMaximum profit is unlimited if the stock ends above 60
  3. CMaximum loss is USD 10 per share if the stock ends at 50
  4. DThe position profits most if the stock moves far from 50 in either direction

Explanation

This is a long call butterfly. Payoff peaks at 10 when the stock is at 50 and is zero below 40 and above 60 (the long 60 call offsets the two short 50 calls). Because it is typically a net debit, the loss is limited to the premium. The other statements describe a straddle or misread the payoff.

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