Question

True/False:

1) When selling a bear spread, the profit graph is always lower than the payoff graph.
2) Chandrika goes short a bull spread on a non-dividend paying stock, built using call options. One call is struck at $33.00 and costs $8.77. The other call is struck at $38.00 and costs $7.45. The cc interest rate is 4.250% and the time to expiry is 5 months. The breakeven point for the profit on the trade is $34.32.
3) If an American style option is worth the same as an otherwise identical (same underlying, same strike, same expiry) European style option, then so is the (otherwise identical) Bermuda style option.
4) For European style options, Put Call Parity guarantees that the Put price plus the Call price (same underlying stock, same strike price K, same expiry) equals the spot price S of the stock.
5) When you go long a stock, you buy it at the bid price.

Answer 1

False, True, False, True, False.

Step-by-step explanation:

True/False:

1. False. When selling a bear spread, the profit graph is not always lower than the payoff graph. The profit graph can be higher if the price of the underlying stock decreases.
2. True. The breakeven point for the profit on the trade is calculated as the higher strike price minus the total premium paid divided by 2. In this case, (38 - (8.77 + 7.45))/2 = 34.32.
3. False. The value of a Bermuda style option is not guaranteed to be the same as an otherwise identical American or European style option.
4. True. Put Call Parity states that the price of a European style put option plus the price of a European style call option equals the current stock price.
5. False. When you go long a stock, you buy it at the ask price, not the bid price. The bid price is what a buyer is willing to pay for the stock.