Question 1 Ajax Pharma is a small Danish pharmaceutical company that has patented a new drug Castecko for anxiety. It is currently under FDA consideration for approval in the US. You anticipate that there will be a significant reaction in Ajax's stock price when the FDA decision is announced a month from today. If FDA approves the drug, the potential sales in the US will bump up its stock price by a lot. If FDA does not approve Castecko, the stock price is likely to plummet as Ajax has no more potential to sell the drug in Denmark. You decide to use a straddle strategy where you buy one call option with a strike price of DKK200 and buy one put option with a strike price of DKK150. Both options expire in a month from today. a) Sketch the payoff at maturity for the buyer of the call option as a function of the underlying asset.
Question 1 Ajax Pharma is a small Danish pharmaceutical company that has patented a new drug Castecko for anxiety. It is currently under FDA consideration for approval in the US. You anticipate that there will be a significant reaction in Ajax's stock price when the FDA decision is announced a month from today. If FDA approves the drug, the potential sales in the US will bump up its stock price by a lot. If FDA does not approve Castecko, the stock price is likely to plummet as Ajax has no more potential to sell the drug in Denmark. You decide to use a straddle strategy where you buy one call option with a strike price of DKK200 and buy one put option with a strike price of DKK150. Both options expire in a month from today. a) Sketch the payoff at maturity for the buyer of the call option as a function of the underlying asset.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Question 1
Ajax Pharma is a small Danish pharmaceutical company that has patented a new drug Castecko for
anxiety. It is currently under FDA consideration for approval in the US. You anticipate that there will be
a significant reaction in Ajax's stock price when the FDA decision is announced a month from today. If
FDA approves the drug, the potential sales in the US will bump up its stock price by a lot. If FDA does
not approve Castecko, the stock price is likely to plummet as Ajax has no more potential to sell the drug
in Denmark. You decide to use a straddle strategy where you buy one call option with a strike price of
DKK200 and buy one put option with a strike price of DKK150. Both options expire in a month from
today.
a) Sketch the payoff at maturity for the buyer of the call option as a function of the underlying asset.
Carefully label the axes and show where the option is at the money.
b) Sketch the payoff at maturity for the buyer of the put option as a function of the underlying asset.
Carefully label the axes and show where the option is at the money.
c) Sketch the payoff at maturity of the straddle i.e. of a portfolio consisting of both the call and the
put. Make sure to label the axes carefully.
d) Explain why it can be a reasonable trading strategy to buy a straddle on the stock of Ajax given
the information above.
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