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FRM Part I · FRM Exam Part I · Trading Strategies

An analyst buys one European call and one European put on the same stock, with the same strike price and the same expiry. Which view of the stock does this long straddle express?

A long straddle, a call plus a put with the same strike and expiry, expresses a view that the stock will move substantially in either direction. It profits from large price changes, or higher volatility, and loses at most the premiums paid if the price ends near the strike.

  1. AThe stock price will move substantially in either direction, with little view on directionCorrect
  2. BThe stock price will remain very close to the strike price until expiry
  3. CThe stock price will rise moderately but not by a large amount
  4. DThe stock price will fall moderately but not by a large amount

Explanation

A long straddle pays off when the terminal price is far from the strike, because one option ends deep in the money while the loss is limited to the total premium. It profits from large moves in either direction, i.e. a bet on high volatility. Betting on a price staying near the strike is the short straddle.

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