CMFAS RES 2B OTC Derivatives: Products & Mechanics question: straddle

CMFAS RES 2BOTC Derivatives: Products & Mechanics

A straddle is constructed by:

A Buying a call and a put at the same strike and expiry, to gain from a big move
B Buying two calls at different strikes on the same underlying and the same expiry
C Selling the underlying and buying a call on it at the current price
D Buying a call and selling a put at the same strike and expiry

Show the answer and explanation

Answer: A. Buying a call and a put at the same strike and expiry, to gain from a big move

A long straddle pays off if the underlying moves far enough in either direction to cover both premiums; it is a bet on volatility, not direction. Buying a call and selling a put at the same strike is a synthetic long forward.

Common mistake

Straddle = volatility play; synthetic forward = directional.

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