Chapter 20, Problem 27PS

a.

Summary Introduction

To draw: A payoff graph for the above said strategy at the option expiration date.

Introduction:

Payoff graph: It is supposed to be a graphical representation of potential outcomes of a strategy. The vertical axis depicts the profit/loss on option expiration day while the horizontal axis depicts the underlying asset price on expiration day.

b.

Summary Introduction

To draw: A profit graph for the above said strategy.

Introduction:

Profit graph: It can also be called as risk graph. Profit graph is supposed to be visual depiction on possible outcomes of an options strategy on a graph. On the vertical axis, the profit/loss is depicted whereas the horizontal axis depicts the underlying stock price on expiration date.

c.

Summary Introduction

To compute: The break-even point for the above said strategy. Also, state whether the investor is bullish or bearish on the stock.

Introduction:

Bull spread: It is a concept used in the trading of options. It is supposed to be a bullish vertical spread options strategy where profit can be earned only when there is a moderate increase in the underlying asset’s price.

Bear spread: It is a concept used in the trading of options. Normally, an investor buys a contract with a high strike price and sells a contract when the strike price is low. By doing this, there is a chance to earn more profit with a decrease in price.