Question

Suppose that call options on a stock with strike prices $300 and $345 cost $30 and $25, respectively. How can the options be used to create a bull spread?

                               Call 1 – Strike $300: Position Long or short?__________

Call 2 – Strike $345: Position Long or short?__________

                  I.            Construct a table that shows the profit and payoff for the spread.

                II.            When is the Maximum profit? How much?

              III.            Draw a diagram for the spread showing the total value of the spread and both call options.

Answer 1

Call1 - strike $300 - Position Long or short?: Long

Call2 - strike $345 - Position Long or short? Short

l).

Bull spread can be built by buying one at the money call option with lower strike price, and writing one out of the money call option with higher strike price.

Expiry	Call1	Call2	Total Debit	Total Payoff
<300	0	0	-5	-5
305	5	0	-5	0
345	45	0	-5	40
>345	45+x	-x	-5	40

ll).

Maximum Profit is obtained when the stock expires greater than or equal to 345. And the maximum profit is $40

lll).

Diagram is attached below: