Question

You have $100,000 to invest. Your investment strategy must include at least two options on a stock of your choice (all options must be on the same stock). They can be either calls or puts or both, with any strike price, as long as all options in your portfolio expire on the same date, and that date is no earlier than June 2020. You can build spreads, straddles, collars, etc. – your choice. Buy them or write them – your choice. Buy at the ask and sell at the bid.

Make sure you pick liquid options, i.e. options that actually trade daily with substantial trading volume.

Whatever positions you take, assume you will liquidate them on April 20, 2020.

Design an investment strategy that would pay off in the event that you believe is the most likely outcome of the stock. For example, your stock is having the earnings call soon. If you believe that the earnings call will result in a positive surprise and the stock price will increase, you should design an option strategy that will pay off if the stock price goes up. Or if you think that the direction of the surprise is hard to predict but you expect a significant surprise either way, design an option strategy that will pay off in the event of high volatility. Etc., whichever outcome you bet on, design an option strategy that will pay off in that case.

When designing your strategy, think about maximizing return while minimizing risk.

Answer 1

Say, I am looking at the stock of company A which I expect to show huge volatility at the earnings release for the first quarter. This strategy is called the long straddle. What I shall do is that I will buy a put and a call option on the stock A. Now, say I expect at least a movement of 10% in either directions, I shall buy a put with a strike price equal to 92% of the current stock price and a call option with a strike price equal to 108% of the current stock price. Now, any movement of the stock price greater than 8% shall effectively provide me the ability to gain, and considering 2% as the cost of purchasing these options, I shall be in green if my expectations of volatility of greater than 10% materialises. With this strategy I limit my risk to 2% of the stock price, while virtually gaining the most of volatility in both directions.