Question

4. Suppose PDQ stock is currently selling for $40 and the call with a $40 strike price on the stock is selling for $2.00 and the call with a $60 strike price is selling for $1.00. Calculate the value of a bearish call spread portfolio if the stock price is $10, $20, $30, $40, $50, $60, $70 and $80. (30 Points)

Answer 1

Bear call spread portfolio can be created by buying call option with higher strike price with simultaneous selling of call option with lower strike price.

Here, to form a bear call spread portfolio can be created by by buying call option with strike price $60 and selling call option with strike price $40

Net gain from buying $60 call option and selling $40 call option= -1+2=$1

Price of stock 1.00 1.00 Payoff from writing $40 call option Payoff from buy of $60 call option Net Gain by forming the bear spread Value of bear spread(K+L+M) 10.00 $ - $ 1.00 $ 20.00 $ - $ 1.00 $ 1.00 30.00 $ - $ - $ 1.00 $ 40.00 $ $ 1.00 $ 1.00 50.00 $ (10.00 $ 1.00 $ (9.00) 60.00 $ (20.00) $ $ 1.00 $ (19.00) 70.00 $ (30.00) $ 10.00 $ 1.00 $ (19.00) 80.00 $ (40.00 $ 20.00 $ 1.00 $ (19.00) - unaona

When you buy position on call option with strike price $60, payoff will be (price of stock-60) when stock price is more or equal to 60, otherwise the option is going to expire.

And when you sell option with strike price $40, the option will expire if price of stock less than or equal to $40 , other wise the option buyer will expire the option and you will have to pay amount equal to =(price of stock-40).