Discussion in 'Today's Daily Questions' started by Suzanne Evans, Aug 14, 2012.

Questions:

211.1. Among the following four strategies, which trading strategy both (i) involves an initial cash inflow to the investor and (ii) a positive future payoff in the event of a sufficiently low future stock price (option profit = future payoff - initial cost, without regard to time value of money)?

211.2. Today (T0), the current price of a stock is $20.00. Also today, the price of a six-month at-the-money (ATM) call option and an one-year ATM call option on the same stock is, respectively,$1.88 and $2.75. The strike price of both calls is$20.00 (i.e., ATM). Over the subsequent six months, it happens that the stock price, the stock's volatility and the risk-free rate are all unchanged: in six months, the stock price remains $20.00, the stock's volatility remains at 30.0%, and the riskfree rate remains at 4.0%. In six months (T+ 0.5 years), at expiration of the shorter maturity option, what is the profit of a neutral calendar spread ("neutral" refers to the use of ATM call options to employ the calendar spread)? a. -$0.87
b. Zero
c. +$1.01 d. +$2.75

a. A spread trade involves taking a position in two or more options of the same type; i.e., two or more calls or two or more puts
b. All of the long spread trades listed above generate a profit, with regard to time value of money, if the underlying stock price is unchanged (constant) over the option lives
c. All of the long spread trades listed above have a limited (capped) downside
d. All of the long spread trades listed above have a limited (capped) upside

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2. ### SMLNew Member

Hi David,
Answer to the first question(211.1) should be C i.e. "Bear spread with calls", since here Long call has higher strike rate than Short call. so short call will have higher premium resulting cash inflow.
But the Bionic FRM Practice book (page - 27) states the answer as D with following explanation -
The bulls spread returns a positive payoff in the event of a HIGH future stock price.
The bear spread returns a positive payoff in the event of a LOW future stock price.
The bear call spread buys a call with strike (K1) and sells a call with a higher strike (K2),
where K2 > K1, such that the strategy involves an initial cost (outflow).
However, the bear put spread buys a put with strike (k1) and sells a put with a higher strike
(K2), where K2 > K1, such that the strategy involves an initial cash INFLOW as the sold put
is more expensive than the purchased put.

This does not seem correct. Any thought?