In the Midterm Exam of your favorite derivatives pricing course, a really clever student erroneously constructed a
Question:
In the Midterm Exam of your favorite derivatives pricing course, a really “clever” student erroneously constructed a K1-K2 strangle by using in-the-money options. Specifically, he bought a call option with strike price K1, and bought a put option with strike price K2, where K1 < S(0) < K2.
Determine which of the following statements about the student’s “strangle” and a correct K1-K2 strangle is/are correct.
I. Both positions are long with respect to the underlying asset.
II. Both positions have the same payoff at expiration.
III. Both positions have the same profit.
(A) I only
(B) II only
(C) III only
(D) II and III only
(E) The correct answer is not given by (A), (B), (C), or (D)
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C We first determine the payoff function of the students stra...View the full answer
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