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IAI Actuarial Core Principles · Economic Modelling · Principles of option pricing

A trader buys one call (strike Rs 300) at Rs 15 and one put (strike Rs 300) at Rs 10 on the same share and expiry. Ignoring interest, between which share prices at expiry does the trader make a loss?

The trader loses money for share prices between Rs 275 and Rs 325. The straddle costs Rs 25 in total and pays |S-300|, so profit is negative whenever the share ends within Rs 25 of the strike.

  1. ABetween Rs 275 and Rs 325Correct
  2. BBetween Rs 285 and Rs 315
  3. CBetween Rs 290 and Rs 310
  4. DBetween Rs 300 and Rs 325
  5. Between Rs 270 and Rs 330

Explanation

This is a straddle with total premium 25. Payoff is |S - 300|. Profit is |S - 300| - 25, which is negative when |S - 300| < 25, i.e. 275 < S < 325. Option B uses 15 only, and option C uses 10 only.

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