Question

You are a portfolio manager who uses options positions to customize the risk profile of your clients. In each case, what strategy is best given your client’s objective?

a. Performance to date: Up 16%.

Client objective: Earn at least 15%.

Your scenario: Good chance of large stock price gains or large losses between now and end of year.

i. Long straddle

ii. Long bullish spread

iii. Short straddle

b. Performance to date: Up 16%.

Client objective: Earn at least 15%.

Your Scenario: Good chance of large stock price losses between now and end of year.

i. Long put options

ii. Short call options

iii. Long call options

Short answer

a. (i) Long straddle

b. (i) Long put option

Step-by-step solution

Explanation of correct answer for ‘a’

Long straddle:-

Yes, that’s correct. An options strategy where the trader purchases both the long call and long put on the same asset with the same expiration date and strike price is known as a long straddle. It provides the option holder benefit in case of movement in either direction.

Explanation of incorrect answer for ‘a’

Long bullish spread:- No, that’s incorrect because it only leads to profit when [rice of underlying assets rises.

Short straddle:- No, that’s not correct because it consists of a short call and a short put on the same underlying stock, strike price, and expiration date, but it is beneficial in case of a small movement in either direction.

Explanation of correct answer ‘b’

Long put options:- It is the correct option because the option holder earns a profit when the stock price goes down sharply from the exercise price.

Explanation of incorrect answer for ‘b’

Short-call options: It is not a correct option because, in this case, the writer will be at a loss if the price goes down sharply because the writer has to deliver the security.

Long call options: It is not correct because this strategy is beneficial when the option holder is bullish and expects a price increase in the future.