Question

A stock price is $25. An investor buys one put option contract on the stock with a strike price of $24 and sells a put option contract on the stock with a strike price of $22.50. The market prices of the options are $2.12 and$1.95, respectively. The options have the same maturity date. Describe the investor's position and the possible gain/loss he will get (taking into account the initial investment).

Answer 1

The position is a bear put spread.

Maximum possible loss = net premium paid = $2.12 - $1.95 = $0.17

Maximum possible gain = strike price of long put - strike price of short put - net premium paid

Maximum possible gain = $24 - $22.50 - $0.17 = $1.33

Breakeven point = strike price of long put - net premium paid = $24 - $0.17 = $23.83

If the stock price at expiry is below $23.83, the investor will make a profit.