Question
a) A trader implements a short strangle strategy by selling a 3-month European put option with a strike price of 75 and a price of
a) A trader implements a short strangle strategy by selling a 3-month European put option with a strike price of 75 and a price of 7 and simultaneously selling a European call option with a strike price of 100 and a price of 5. i. Draw the profit and loss diagram of the strategy and create the profit and loss table for the possible range of values of the underlying asset at maturity. ii. What is the market view when adopting this strategy? iii. What is the main risk associated with the strategy? Use a real-life example in your answer. b) Why is it never optimal to exercise an American call option before its maturity? c) Explain what is meant by a perfect hedge. Does a perfect hedge always lead to a better outcome than an imperfect hedge? Explain your answer.
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