Part A. An investor predicts that the price of XYZ stock will exhibit unusually
ID: 2809390 • Letter: P
Question
Part A. An investor predicts that the price of XYZ stock will exhibit unusually low volatility in the
coming month. Which of the following is the best strategy for the investor to profit from this
prediction?
a. Write a covered call
b. Establish a long straddle
c. Write a straddle
d. Write a time spread
Part B. Turn back to figure 20.1, which lists prices of various IMB options. Use the data in the
figure to calculate the payoff and profits for investments in each of the following January
maturity options, assuming that the stock price on the maturity date is $125
a. Call option, X = 120
b. Put option, X = 120
c. Call option, X = 125
d. Put option, X = 125
e. Call option, X = 130
f. Put option, X = 130
Explanation / Answer
Answer(a): Writing a Straddle will give profit from low volatility. Option "c" is correct.
Write a straddle- This strategy involves selling both, call and put of the same expiration and strike price. This strategy is taken when there are less movements in the underlying stock. This strategy is not for beginners rather than for advance traders.
When to take- Less volatility
Execution- In this strategy one ATM call and one ATM put are sold
Maximum profit- Limited to the premium received by selling both options.
Maximum loss- Unlimited