A bear spread using put options is created by buying the put option having a higher strike price and simultaneously selling / writing the put option with a lower strike price. Both the options should have the same expiry dates.
Hence, in the given problem we will create the bear spread by
i) Buying put option with a strike of 45 for $8 and
ii) Selling the put option with a strike of 40 for $5, thereby resulting into a Net Investment of $(8-5) = $3
Maximum profit potential from this position = (Difference between two strike prices) - (Original Investment Made)
Difference between two strike prices = (45-40) = 5
Hence, Maximum profit potential from this position = (5-3) = $2
Stock Price | Original Investment | Pay-out from the Bear Spread | Net Profit |
45 | -3 | 0 | -3 |
44 | -3 | 1 | -2 |
43 | -3 | 2 | -1 |
42 | -3 | 3 | 0 |
41 | -3 | 4 | 1 |
40 | -3 | 5 | 2 |
Note: If the (Stock Price > 45) at the expiration, there will be no pay-out from bear spread.
Also, even if (Stock Price < 40) at the expiration, the profit will be limited to $2
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