Question

Suppose that put options on a stock with a strike price $40 and $45 cost $5 and $8, respectively. How can you use these options to create a bear spread? Draw a diagram to show the profit of the spread

Answer 1

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

А в Stock Price Original Investment Pay-out from the Bear Spread Net Profit -2 -1 2 3 2

A в Ε -3 Stock Price Original Investment Pay-out from the Bear Spread Net Profit =$B$3-B3 =C3+D3 44 =$B$3-B4 =C4+D4 =$B$3-B5 =C5+D5 =$B$3-B6 =C6+D6 =$B$3-17 =C7+D7 =$B$3-B8 =C8+D8 43

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