Question

A 6-month European call option with a strike price of $25 costs $2.24. A 6-month European put
option with a strike price of $20 costs $1.31. 
a. Explain how a strangle can be created from these two options.
b. Construct a table that shows the profit from the strategy.
c. For what range of stock prices would the strategy lead to a profit.

Answer 1

a. A strangle can be created by buying a call option and a put option with different strike prices. In this case, a strangle can be created by buying the 6-month European call option with a strike price of $25 and the 6-month European put option with a strike price of $20. b. Profit from the strategy can be calculated by subtracting the cost of the options (the premium paid) from the difference between the strike price and the stock price at expiration. The table below shows an example of the profit for different stock prices at expiration: Stock Price at Expiration Profit $15 -3.55 $20 -0.31 $25 2.24 $30 5.49 $35 8.74 c. The strategy would lead to a profit if the stock price at expiration is between $20 and $25. Below $20, the put option would expire in the money, and above $25, the call option would expire in the money.