Question

Suppose you use a call spread strategy on 4/15/2020, by buying a Facebook call option with the strike price of $180 at $7 and selling a Facebook call option with the strike price of $195 at $2. Both call options mature on 5/15/2020.

(a) What is your total payoff and profit if Facebook share is traded at $170 on 5/15/2020?

(b) What is your total payoff and profit if Facebook share is traded at $185 on 5/15/2020?

(c) What is your total payoff and profit if Facebook share is traded at $200 on 5/15/2020?

Answer 1

a. The total payoff is computed as shown below:

Payoff of buying a call option is computed as follows:

= Price at expiration - Strike Price - Premium paid

= $ 170 - $ 180 - $ 7

= - $ 17

But the maximum loss is restricted to the amount of premium paid i.e. $ 7

Payoff of selling a call option is computed as follows:

= Strike Price - Price at expiration + Premium paid

= $ 195 - $ 170 + $ 2

= $ 27

But the maximum profit is restricted to the amount of premium paid i.e. $ 2

So, the total profit or loss will be:

= (- $ 7 + $ 2) x 100

= - $ 500

b. The total payoff is computed as shown below:

Payoff of buying a call option is computed as follows:

= Price at expiration - Strike Price - Premium paid

= $ 185 - $ 180 - $ 7

= - $ 2

Payoff of selling a call option is computed as follows:

= Strike Price - Price at expiration + Premium paid

= $ 195 - $ 185 + $ 2

= $ 12

But the maximum profit is restricted to the amount of premium paid i.e. $ 2

So, the total profit or loss will be:

= (- $ 2 + $ 2) x 100

= $ 0

c. The total payoff is computed as shown below:

Payoff of buying a call option is computed as follows:

= Price at expiration - Strike Price - Premium paid

= $ 200 - $ 180 - $ 7

= $ 13

Payoff of selling a call option is computed as follows:

= Strike Price - Price at expiration + Premium paid

= $ 195 - $ 200 + $ 2

= - $ 3

So, the total profit or loss will be:

= ($ 13 - $ 3) x 100

= $ 1,000