Strangle

A customer expecting a stock to trade in a narrow range and wanting premium income (accepting large risk) might establish:

1. A.A short strangleCorrect - income if range-bound, large risk.
2. B.A long call onlyA long call pays premium out rather than collecting it, so it produces no income. It also needs the stock to rise meaningfully, while this customer expects the price to stay in a narrow range.
3. C.A long straddleThis is the mirror image of what the customer wants. A long straddle costs two premiums and profits only from a large move in either direction, so a range-bound stock is exactly the outcome that makes it lose.
4. D.A protective putA protective put is a hedge bought to insure a long stock position against a decline. It costs premium instead of generating it, and it expresses no view about the stock staying in a range.

Why: Selling a strangle or straddle collects premium in a flat market, with substantial risk on a big move.

With the stock at $50, Hyacinthe Delacroix-Ng writes one 55-strike call for a premium of $2 and one 45-strike put for a premium of $1.50, both expiring in the same month. What is her maximum gain, and under what condition is it realized?

1. A.$200, realized if the stock closes above $55This counts only the call premium and describes a condition under which the short call loses money.
2. B.$350, realized if the stock closes between $45 and $55Correct. Both premiums total $3.50 per share and are kept in full only if both options expire worthless.
3. C.Unlimited, because the stock could rise indefinitelyUnlimited describes her LOSS potential on the short call, not her gain.
4. D.$1,000, the difference between the two strike pricesThe strike spread is not a gain on a short strangle; there is no long option to cap the position.

Why: This is a short strangle: the writer sells an out-of-the-money call and an out-of-the-money put with the same expiration. The maximum gain equals the total premium received, $2 plus $1.50 equals $3.50 per share, or $350 for the one-contract pair, and it is realized only if both options expire worthless, which occurs when the stock finishes between the two strikes. The position profits from low volatility and carries unlimited loss potential on the upside.

An investor buys 1 XYZ October 50 call at 4 and simultaneously buys 1 XYZ October 45 put at 2, establishing a long strangle. What are her breakeven points and her maximum loss?

1. A.Breakevens of 56 and 39, with a maximum loss of 400 dollarsThe breakevens are right, but she paid for both options, so her total risk is 600 dollars, not just the call premium.
2. B.Breakevens of 56 and 39, with a maximum loss of 600 dollarsCorrect. Each breakeven is measured from its own strike by the full 6-point combined premium.
3. C.Breakevens of 50 and 45, with a maximum loss of 600 dollarsThese are simply the two strike prices. Breakeven must also cover the premium she paid.
4. D.Breakevens of 54 and 43, with a maximum loss of 600 dollarsThe maximum loss is right, but each breakeven was computed using only one leg's premium instead of the combined 6 points.

Why: Total premium paid is 6 points, or 600 dollars. On the upside the stock must clear the call strike by the full premium, so the breakeven is 50 plus 6, or 56. On the downside it must fall below the put strike by the full premium, so the breakeven is 45 minus 6, or 39. Between 45 and 50 both options expire worthless and she loses the entire 600 dollars. The clue is that the two strikes differ, which is what separates a strangle from a straddle.

Expecting a large move in Verrick Diagnostics ahead of a clinical trial readout but genuinely unsure of the direction, Anneke Roosevelt buys 1 Verrick October 55 call at 2.40 and buys 1 Verrick October 45 put at 1.60. The stock trades at $50. Ignoring commissions, her breakeven points at expiration and her maximum loss are:

1. A.Breakevens of $57.40 and $43.40, with a maximum loss of $400.Incorrect. This nets each option's own premium against its own strike. Both breakevens must recover the ENTIRE $4.00 debit, not just one leg of it.
2. B.Breakevens of $59.00 and $41.00, with a maximum loss of $400 realized anywhere between $45 and $55 at expiration.Correct. Upside breakeven is 55 + 4 = $59; downside breakeven is 45 - 4 = $41. Between the strikes both options expire worthless and the full $400 debit is lost.
3. C.Breakevens of $54.00 and $46.00, with a maximum loss of $400.Incorrect. This subtracts the premium from the call strike and adds it to the put strike, moving the breakevens toward the current price rather than away from it.
4. D.Breakevens of $59.00 and $41.00, with an unlimited maximum loss.Incorrect on the loss. Unlimited risk belongs to the SHORT strangle. A purchaser of options can lose no more than the premium paid.

Why: This is a long strangle: a long out-of-the-money call and a long out-of-the-money put with the same expiration but different strikes. The total debit is 2.40 + 1.60 = 4.00, or $400 for the pair. To profit, the stock must move far enough past one strike to recover the ENTIRE premium. Upside breakeven is the call strike plus the total premium: 55 + 4 = $59. Downside breakeven is the put strike minus the total premium: 45 - 4 = $41. If the stock finishes anywhere between $45 and $55, both options expire worthless and Anneke loses the full $400, which is her maximum loss.