Question

Three put options on a stock have the same expiration date and strike prices of $50, $60, and $70. The market prices are $3, $5, and $9, respectively. Alice buys the $50 put, buys the $70 put and sells two of the $60 puts. What is the maximum loss that Alice can face?

		$2
		$1
		$3
		Infinity

Answer 1

A. $2

$2 is the maximum loss that Alice can face. Buy buying $50 and $70 puts and by selling two $60 puts, the initial payoff for Alice is -3+10-9= -2.

Now, if the stock expires below $50, then the profit from buying $50 and $70 puts gets knocked off with selling two $60 puts. If the stock expires greater than 50, then Alice will realise profit and the greater the price it expires after 50, the greater the profit will be.

So, Alice will lose a maximum of $2 when the stock expires below $50.