Consider a “long strangle” constructed from options which have an expiration dat
ID: 2720365 • Letter: C
Question
Consider a “long strangle” constructed from options which have an expiration date of January 15, 2016 (the third Friday in January). The following table displays the possible prices of Boeing stock on January 15, as well as the payoffs accruing to someone who holds a long strangle on Boeing stock:
A. What will it cost an investor to buy a long strangle today?
B. A long strangle is created using two options. For each option in the strangle above, indicate whether it is a put or a call, whether it is bought or sold, and calculate what its strike price is. Explain your answer.
C.Why would someone buy a long strangle? Explain carefully.
Explanation / Answer
A Stock Price Gain from Strangle Probability Fair Price 80 15 0.2 3 90 5 0.3 1.5 100 0 0.2 0 110 10 0.2 2 120 20 0.1 2 Total 8.5 Cost to Investor Today 8.5 B Long Strangle Donates Call Buyer and Put Buyer situation Call Buyer has bought the Right to Purchase & Put Buyer has Bought the right to sell the Share Gain is Zero at Stock Price 100, So it is the Strike Price C One should go for Long Strangle when the Rise in Price is expected more than the Fall in Price Thank you!