Strips and straps are variations on the straddle. The investor buys a straddle (i.e., buys a put and a call with the same strike price and expiration date) when he or she expects the price to move but is uncertain of the direction of change. A strip involves buying one call and two puts with the same strike price and expiration date. The strip places more emphasis on the price of the stock declining. A strap consists of buying two calls and one put. It places more emphasis on the price of the stock rising. (Another variation is a strangle in which the investor buys a put and a call with the same expiration dates but different strike prices.) Suppose a stock is selling for $41 and there are three-month options at $40. The call is selling for $3, and the put is selling for $1.
a) What would be the gains or losses at the options' expiration if you construct a straddle, a strip, or a strap when the following are the prices of the stock: $30, $35, $38, $40, $42, $45, and $50?
b) What is the maximum possible loss under each strategy?
c) What is the range of stock prices that produces a loss under each strategy?