FRM Part I · FRM Exam Part I · Trading Strategies
An investor buys one European call and one European put on the same stock, with the same strike price of $50 and the same expiry. The call costs $4 and the put costs $3. Ignoring discounting, what is the maximum loss on the position and at what final stock prices does it occur?
The long straddle loses at most the total premium of $7, and this happens only if the stock ends exactly at the $50 strike, when both options expire worthless. At $43 or $57 the position merely breaks even.
- A$7, when the stock price at expiry equals $50Correct
- B$7, when the stock price at expiry is $43 or $57
- C$4, when the stock price at expiry is below $50
- D$3, when the stock price at expiry is above $50
Explanation
This is a long straddle with total premium paid of $4 + $3 = $7. The maximum loss equals the premium and occurs when both options expire worthless, which happens only when the final price equals the strike of $50. At $43 or $57 the position breaks even, so the second option is wrong.
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