Saturday, July 10, 2010

Straddle question

Bobby Bobson bought a BCD Mar 55 call @3 and a BCD Mar 55 put @3.50. If BCD becomes worthless, the resulting profit or loss would be
A. loss of $650
B. loss of $5,200
C. gain of $650
D. gain of $4,850

EXPLANATION: the questions on the exam are often not as clear as you'd like. What does it mean "if BCD becomes worthless"? It means the underlying common stock goes to zero, kaput. So, Bobby loses just the total premium of $650, right?
Not right. If the stock becomes worthless, the right to sell it (Mar 55 put) is worth $5,500. $5,500 minus the $650 he paid for the position = a gain of $4,850.


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