rrent stock price S is $22.

Time to maturity T is six months.

Continuously

compounded, risk

-free interest rate r is 5 percent per

annum

. European options

prices are given in the following table:

Strike Price

Call Price

Put Price

K1=$17.50

$5.00

$0.05

K2=$20.00

$3.00

$0.75

K3=$22.50

$1.75

$1.75

K4=

$

25.00

$0.75

$3.50

(a)

What is the aim of a long (or bottom) straddle strategy?

Create a long

straddle by buying a call and put with strike price K3

=$22.50 [

10 mark

s]

(b)

What is the aim of a short (or top) strangle strategy?

Create a short strangle

by writin

g a call with strike price

K3=$22.50 and a put with strike price

K2 =$20.

[10 mark

s]