CFA Level II ExamDerivativesMedium
A speculator is evaluating a long strangle strategy. The current stock price is $100. The speculator buys a 3-month call option with a strike price of $110 for a premium of $3.00 and simultaneously buys a 3-month put option with a strike price of $90 for a premium of $2.50. Ignoring transaction costs, what is the breakeven point on the upside for this strategy?
- A$115.50
- B$94.50
- C$118.00
- D$105.50
Show answer & explanationAnswer & explanation
Correct answer: A. $115.50
A long strangle involves buying an out-of-the-money call and an out-of-the-money put with the same expiration date. The upside breakeven point is calculated as the Call Strike Price + Total Premiums Paid. Total Premiums = $3.00 (call) + $2.50 (put) = $5.50. Upside Breakeven = $110 (Call Strike) + $5.50 = $115.50.
Why the other options are wrong
- B. Incorrect; this is the downside breakeven point ($90 - $5.50 = $84.50), but the option uses $94.50, which is incorrect for downside breakeven.
- C. Incorrect; calculation error, possibly adding only the call premium to the call strike or another miscalculation.
- D. Incorrect; this might be a miscalculation involving the current stock price or an incorrect premium sum.
Long Strangle Breakeven (Upside)
The upside breakeven point for a long strangle strategy is the strike price of the call option plus the total premiums paid for both the call and put options.
- A long strangle involves buying an out-of-the-money call and an out-of-the-money put.
- It profits from a large price movement in either direction.
- Total premiums paid reduce potential profit and define breakeven points.
Memory trick: Strangle's Break: Call Strike + Total Premium for UP, Put Strike - Total Premium for DOWN!