The common stock of the P.U.T.T. Corporation has been trading in a narrow price

Question

The common stock of the P.U.T.T. Corporation has been trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next three months. You do not know whether it will go up or down, however. The current price of the stock is $110 per share, the price of a three-month call option with an exercise price of $110 is $9, and a put with the same expiration date and exercise price costs $7.

a. What would be a simple options strategy to exploit your conviction about the stock price’s future movements?

b. How far would the price have to move in either direction for you to make a profit on your initial investment?

Stock price must move up above $ , or move down below $ for you to make a profit.

Sell both a put option and a call option on the stock. Buy both a put option and a call option on the stock. Buy a put option and sell a call option on the stock. Sell a put option and buy a call option on the stock.

Explanation / Answer

Buy both a put option and a call option on the stock. This is known as buying a straddle. The total cost of straddle will be = 9+7= $16. $16 is the amount by which the stock would have to move in either direction to make a profit.

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