Question

Part 1 

What does a stop order to sell at $2 mean? When might it be used? 

Part 2

Six-month call options with strike prices of $35 and $40 cost $7 and $4, respectively. What is the maximum gain when a bull spread is created from the calls?

Answer 1

Part 1 -

Stop Order - It's an order to buy or sell a security when its price goes beyond a particular point, to limit the investor's loss. Once the price crosses the particular point, the stop order becomes a market order.
A stop order to sell at $2 is a market order to sell once a price of $2 is reached.
It could be used to limit the losses in a long position.

Part 2 -

Bull call spread is utilized when there is a probability of a moderate increase in price. It involves buying a call at a lower strike price and selling a call at a higher strike price.

Assuming we have 200 options traded. This means that 100 options are sold and 100 options are bought.

Bought option is $35 strike option and sold option is $40 strike option.

Since the $40 strike option is sold, the gain cannot be higher than $40, because any rise above $40 will go to the option buyer (counter party). Any fall below $35 shall be arrested by $35 strike option which has been bought. Therefore the maximum gain is $5 per pair of options and there is 100 pair of options, so the gain is $500.

Now the $35 strike option costs us $7 and $40 strike option provides us with $4 premium. Therefore net inflow =$7-$4=-$3

On a 100 pair of options =-$3*100=-$300

Total gain =$500-$300=$200