Question

The common stock of the Avalon Corporation has been trading in a narrow range around $40 per share for months, and you believe it is going to stay in that range for the next three months. The price of a three-month put option with an exercise price of $40 is $3, and a call with the same expiration date and exercise price sells for $4. Selling a straddle would generate total premium income of _____. $300 $400 $500 $700

Answer 1

Answer:

$700

Explanation:

Given that

Price of a 3 month put option = $3

Price of a 3 month call option = $4

Considering the above

Selling the straddle = sell a put + sell a call

Thus,

Total premium income from selling a stradle = (P + C)100

Where,

P is price of put

C is price of call

Therefore,

Total premium from selling a stradle

= (3 + 4)100

= 7 × 100

= $700

Answer 2

Answer:

$700

Explanation:

Selling a straddle means that you are going to both sell a call option and a put option. Since you expect that the price of Avalon's stock remains around $40, then if you sell either a call or put option, at $40, you will not lose money if the other trader decides to execute their option.

Each call option is priced as $3 per share = $3 x 100 shares = $300

Each put option is priced as $4 per share = $4 x 100 shares = $400  

                                                                                    total gain = $700

So if everything goes as planned, you should be able to earn $700. If the price of the shares changes, then you earnings will be a little lower.