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The current price of a non-dividend paying stock is 40 and the continuously com- pounded risk-free interest rate is 8%. The following table shows call and put option premiums for three-month European of various exercise prices: Exercise Price Call Premium Put Premium 35 6.13 0.44 40 2.78 1.99 45 0.97 5.08 A trader interested in speculating on volatility in the stock price is considering two in- vestment strategies. The first is a 40-strike straddle. The second is a strangle consisting of a 35-strike put and a 45-strike call. (a) Write down the profit function for the 40-strike straddle and draw the correspond- ing profit diagram. Please indicate the breakeven stock prices in your diagram. (b) If the stock price at maturity is 50, which option strategy performs better? Find the difference in profits generated by the two strategies. The current price of a non-dividend paying stock is 40 and the continuously com- pounded risk-free interest rate is 8%. The following table shows call and put option premiums for three-month European of various exercise prices: Exercise Price Call Premium Put Premium 35 6.13 0.44 40 2.78 1.99 45 0.97 5.08 A trader interested in speculating on volatility in the stock price is considering two in- vestment strategies. The first is a 40-strike straddle. The second is a strangle consisting of a 35-strike put and a 45-strike call. (a) Write down the profit function for the 40-strike straddle and draw the correspond- ing profit diagram. Please indicate the breakeven stock prices in your diagram. (b) If the stock price at maturity is 50, which option strategy performs better? Find the difference in profits generated by the two strategies

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