Question

1. You are bullish about an underlying that is currently trading at a price of $80. You choose to go long one call option on the underlying with an exercise price of $75 and selling at $10, and go short one call option on the underlying with an exercise price of $85 and selling at $2. Both the calls expire in three months.

1. What is the term commonly used for the position that you have taken?
2. Determine the value at expiration and the profit for your strategy under the following outcomes:
   1. The price of the underlying at expiration is $89.
   2. The price of the underlying at expiration is $78.
   3. The price of the underlying at expiration is $70.
3. Determine the following:
   1. the maximum profit.
   2. the maximum loss.
4. Determine the breakeven underlying price at expiration of the call options.

Answer 1

	A	Term commonly used for the position is Bull Call Spread
		This Strategy is used when the trader thinks that there will be limited increase in price
		The trader buys call option at a certain strike price and also sells call option at higher strike price
		Selling at higher strike price reduces his total premium expense
		For example, in the case premium expense is reduced by $2
	B	Payoff in Buying(Long) Call option at strike price=$75:
		Price at expiration =S
		If S< or=$75, Payoff=$0
		If S>$75, Payoff =$(S-75)
		Payoff in Short(Selling) Call option at strike price=$85:
		Price at expiration =S
		If S< or=$85, Payoff=$0
		If S>$85, Payoff =$(85-S): Negative Payoff meaning Loss
		Net Premium Cost=$10-$2=$8
			A	B	C	D=A+B+C
			Payoff			Net
		The price of the underlying at expiration	Long Call	Short Call	Premium	Profit
	i	$89	$14	($4)	($8)	$2
	ii	$78	$3	$0	($8)	($5)
	iii	$70	$0	$0	($8)	($8)
		$83	$8	$0	($8)	$0
	C	Maximum Profit=$2
		Maximum Loss=$8
	D	Break even will occur when payoff from option =Net Premium paid
		Payoff=$8
		Payoff =(S-$75)+($85-S) if S>85
		If S<85,
		Payoff =(S-$75)=$8
		S-$75=$8
		S=$75+$8=$83
		Break even will occur if Price at expiration=$83
		Answer:
		break even underlying price at expiration of the call option	$83