Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which two assets are involved in forming a long straddle?

1. Long call and short put

2. Long call and long put

3. Short call and long put

4. Short call and short put

The correct answer is: Long call and long put

A long straddle is an options trading strategy that involves buying both a call option and a put option with the same strike price and expiration date. This strategy is employed when an investor predicts a significant price movement in the underlying asset, but is uncertain about the direction of that movement—whether it will rise or fall. By purchasing a long call and a long put, the investor is positioned to benefit from substantial price changes. If the asset’s price increases significantly, the long call option can generate profits. Conversely, if the asset’s price decreases dramatically, the long put option allows for profit as well. The key aspect of this strategy is the simultaneous ownership of both options, which is essential for achieving the desired exposure to volatility. In contrast, the other combinations listed do not align with the mechanics of a long straddle. A long call and short put would create a different risk profile, favoring upside potential with limited downside risks. Meanwhile, combinations involving short calls or short puts would expose the investor to unlimited risk in the case of significant price movements, which contradicts the protective nature of a long straddle. Thus, the correct assets involved in forming a long straddle are indeed a long call and a long put.