Final answer:
In a bull call spread, a profit occurs if the spread narrows or ABC declines sharply. Option c is the correct answer.
Step-by-step explanation:
In this scenario, the customer is implementing a strategy known as a bull call spread. A bull call spread involves buying a call option with a lower exercise price and selling a call option with a higher exercise price, both on the same underlying stock. In this case, the customer buys 1 ABC March 40 call and sells 1 ABC March 35 call.
A profit occurs if the stock price of ABC rises, causing the spread between the exercise prices of the two options to widen. This would result in the bought call option becoming more valuable while the sold call option would decrease in value. Therefore, option I is incorrect.
If the spread between the exercise prices narrows, it means that the stock price of ABC is not moving as much as anticipated. In this case, the bought call option may not gain enough value to offset the decrease in value of the sold call option. Hence, option II is correct.
If ABC declines sharply, the value of both call options in the spread would likely decrease. This means that the customer would not make a substantial profit or may even incur a loss. Thus, option III is correct.
However, option IV is incorrect. Exercising the options is not necessary for a profit to occur in this scenario. Profit or loss is determined by the changes in the value of the options, not by exercising them.
Based on the explanations above, the correct answer is option C) II and III, as these choices accurately represent situations in which a profit can occur in a bull call spread.