Question

You construct a bear spread by selling a 6-month put option with a $25 strike price for $2.50 and buying a 6-month put option with a $29 strike price for $4.50. Compute the spread profit (including the cost) when the stock price in 6 months becomes (a) $23, (b) $26, and (c) $33.

Answer 1

a) 0

b) -1

c) -4

Step-by-step explanation:

Bear spread:

Short P1 = 2.5, X1 = 25

Long P2 = 4.5, X2 = 29

Payoff at expiration = 25-29 + Max (0, 29-ST) - Max (0, 25-ST)

= Max (0,29-ST) - Max (0,25-ST) - 4

a) ST = 23

Spread profit = 6 - 2 -4 = 0

b) ST = 26

Spread profit = 3 - 4 = -1

c) ST = 33

Spread profit = -4