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Consider six-month put options with strike prices of $35 and $40 per share and premiums of...

Consider six-month put options with strike prices of $35 and $40 per share and premiums of $4 and $6 per share, respectively. What is the maximum gain per share when a bear spread is created from the calls? What is the maximum loss per share when a bear spread is created from the calls?

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Expert Solution

When bear spread is created it is expected that prices of share will be declined. In given example there are two situations let us consider them as a independent situation.

1) Strike price $35 - Premium $4

In the option market strike price means exercise price. When share price is on exercise date below $ 35 then buyer of option will exercise the right and his profits will be difference between market price of share and strike price minus premium. Let us say price of share on exercise date is $ 30. then profit will be $35 - $30 -$4 = 1$.

Minium share price on exercise date can be zero hanse maximum profit will be. $35 - $0 - $4 = $31

. If share price on exercise date above $ 35 then buyer of option will exercise the righ.then his loss will be limited to share premium that is $ 4

2) Strike price $ 40 - pre Premium $ 6

If share price on exercise date is above $ 40 then buyer of option will not exercise the option and his loss will be limited to option premium. that is $ 6 . and if share price is below $ 34 ( 40 - 6) then he will be in profit.Minium share price on exercise date can be zero there fore Maximum profit will be $40 -$0 - $6 - = $34  

Above situation are considered for buyer of option.

jeff jeffy answered 1 year ago
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