Long Straddle

A customer establishes a long straddle: buys 1 XYZ 50 call at 3 and 1 XYZ 50 put at 2. The upside breakeven is:

1. A.4545 is a real breakeven for this straddle, just the one on the downside, where the strike less the 5 total premium is reached. The question asks where the position turns profitable on a rally, which is 55.
2. B.5353 adds only the 3 paid for the call and forgets the 2 spent on the put. A straddle buyer must recover the entire 5 point outlay before he profits, so the upside breakeven is 55.
3. C.5252 adds only the put premium to the strike, taking the smaller of the two costs and dropping the other. Both legs were purchased, so the combined 5 points must be added, giving 55.
4. D.55Correct - 50 + 5 total premium.

Why: Total premium = 3 + 2 = 5; upside breakeven = strike + total premium = 50 + 5 = 55.

A long straddle is most profitable when:

1. A.The stock makes a large move in either directionCorrect - it is a volatility bet.
2. B.The stock rises only slightlyA slight rise is not enough. The call gains a little while the put loses value, and the net move must exceed the combined premiums paid before the straddle turns profitable at all.
3. C.The stock stays exactly flatA flat stock is the worst case for a long straddle, not the best. Both options expire at the strike with no intrinsic value and the holder loses the entire premium paid for both legs.
4. D.Rates fallInterest rates are not what drives this position. An equity straddle profits from the size of the move in the underlying stock, regardless of which way rates go.

Why: A long straddle (long call + long put, same strike) profits from a large move up or down; the maximum loss is the total premium.