FRM Part I · FRM Exam Part I · Trading Strategies
A trader buys one call with strike USD 40, buys one call with strike USD 60, and sells two calls with strike USD 50, all European with the same expiry. Which description and expiry payoff at a stock price of USD 50 is correct?
This is a long butterfly spread, with long outer calls and two short middle calls. At a stock price of USD 50 only the USD 40 call is in the money, paying USD 10, so the gross payoff is USD 10 before the net premium.
- ALong butterfly spread; payoff of USD 10Correct
- BLong straddle; payoff of USD 10
- CShort butterfly spread; payoff of USD 10
- DLong butterfly spread; payoff of zero
Explanation
Buying the outer calls and selling two middle calls is a long butterfly, which profits when the price ends near the middle strike. At 50: the 40 call pays 10, the 60 call pays 0, and the two short 50 calls pay 0, so the payoff is USD 10. It is not a straddle because it uses only calls with three strikes.
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