Suppose the DJIA stands at 25,800. You want to set up a long straddle by purchasing 100 calls and an equal number of puts on the index, both which expire in three months and have a strike of 258. The put price is listed at $4.25 and the call sells for $5.25.

a. What will it cost you to set up the straddle, and how much profit (or loss) do you stand to make if the market falls by 750 points by the expiration dates on the options? What if it goes up by 750 points by expiration? What if it stays at 25,800?

b. Repeat part a, but this time assume that you set up a short straddle by selling/writing 100 Oct 258 puts and calls.

c. What do you think of the use of option staples as an investment strategy? What are the risks, and what are the rewards?

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ANSWERS

a. To set up the long straddles, it will cost $________

if the market on the long straddle falls by 750 points by the expiration dates on the options, the profit (or loss) is $________

If the market stays at 25,800 by the expiration dates on the options, the profit (or loss) is $__________

b. Your revenue from setting up the short straddle is $________

If the market on the short straddle falls by 750 points by the expiration dates on the options, the profit (or loss) is $________

If the market stays at 25,800 by the expiration dates on the options, the profit (or loss) is $________

c. What do you think of the use of option straddles as an investment strategy? What are the risks, and what are the rewards? (Select the best choice below)

1) Option straddles are extremely risky. For larger movements in the market, the short straddle will start losing money and the long straddle will start gaining money.

2) Option straddles are not very risky. For larger movements in the market, the short straddle will start losing money and the long straddle will start gaining money.

3) Option straddles are extremely risky. For larger movements in the market, the short straddle will start gaining money and the long straddle will start losing money.

4) Option straddles are not very risky. For larger movements in the market, the short straddle will start gaining money and the long straddle will start losing money.