FRM Part I · FRM Exam Part I · Options Markets
A trader buys a stock at $40, buys a put with strike $40 for $3, and writes a call with strike $45 for $1. All options have the same maturity. What is the maximum profit and maximum loss per share on this collar at expiration (ignoring financing costs)?
Maximum profit is $3 and maximum loss is $2 per share. The net option cost is $2; upside is capped at the $45 strike for a $5 stock gain, less $2, and downside is floored at the $40 put strike, losing only the $2 net premium.
- AMaximum profit $3; maximum loss $2Correct
- BMaximum profit $5; maximum loss $3
- CMaximum profit $3; maximum loss $3
- DMaximum profit $2; maximum loss $2
Explanation
Net cost of options = 3 - 1 = $2. Maximum profit: stock at or above 45 gives (45-40) - 2 = $3. Maximum loss: stock at or below 40 gives put payoff protecting at 40, so loss is the net premium of $2. Ignoring the premium on the call (answer $5/$3) is the mistake in the distractor.
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