The common stock of the Avalon Corporation has been trading in a narrow range ar

Question

The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to move away sharply from the range in the next 3 months. The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4. What would be a simple options strategy using a put and a call to exploit your conviction about the stock price's future movement? A. Sell a call. B. Purchase a put. C. Sell a straddle. D. Buy a straddle.

Explanation / Answer

Answer: C. Sell a straddle

Sell a straddle = sell a put + sell a call

Premium income for selling a straddle = (P + C )100 = ($3 + $4)(100) = $700

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