FINRA Series 7Investment Information and Suitable RecommendationsMedium
A technician observes that ABC stock has been trading in a narrow range between $48 and $52 for several months. They believe the stock is due for a significant price movement but are unsure of the direction. Which options strategy would be most appropriate?
- AProtective Put
- BCovered Call
- CShort Straddle
- DLong Straddle
Show answer & explanationAnswer & explanation
Correct answer: D. Long Straddle
A long straddle is a volatility strategy used when an investor expects a significant price movement in the underlying asset but is uncertain about the direction. It involves buying both a call and a put option with the same strike price and expiration date.
Why the other options are wrong
- A. A protective put is a bearish strategy, used to protect against a decline in a long stock position.
- B. A covered call is a bullish strategy, used when expecting moderate appreciation or stable price, and income generation.
- C. A short straddle profits from minimal price movement, which contradicts the expectation of a significant move.
Long Straddle
A long straddle is an options strategy that involves buying both a call and a put option on the same underlying asset, with the same strike price and expiration date. It is used when an investor anticipates a significant price movement in the underlying asset but is unsure of the direction.
- Consists of one long call and one long put, same strike, same expiration.
- Profits if the stock moves significantly up or down from the strike price.
- Maximum loss is limited to the total premiums paid for both options.
- Breakeven points are Strike Price + Total Premiums and Strike Price - Total Premiums.
Memory trick: Straddle the fence, hope for a big jump, either way, you'll win.