[ 2009 FRM Sample Exam ] Market risk measurement and management Q24 management, butterfly, direction, following, investor

Babul

 

24. Which of the following strategies is the most appropriate strategy to implement if the investor expects a large move in a stock price but is not sure of the direction of the move?

A. Purchase a straddle.

B. Write a straddle.

C. Go long a butterfly spread by buying two call options, one at a relatively low strike price and one at a relatively high strike price, and by selling two call options with strike price between the strike prices of the first two call options.

D. Go long a bull spread.

Babul

 

Correct answer is Afficeffice" />

When an investor expects a large move in stock price, either up or down, he can purchase a straddle which leads to large profit if stock price moves significantly in either direction.

Strategy b) could lead to significant loss if investor's expectation is right.

Strategy c) works if investor believes that large stock price moves are unlikely.

Strategy d) works if investor believes that stock price will increase.

ffice:smarttags" />Reading: John Hull, Chapter 8.