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FRM Part I · FRM Exam Part I · Properties of Options

A trader holds a short European call with strike $50 (premium received $5) and a long European call with strike $60 (premium paid $2) on the same stock and expiry. At expiration the stock trades at $57. What is the net profit per share, and what is the position's maximum possible loss?

The net result is a loss of $4.00 and the maximum loss is $7.00. The position is a bear call spread with a $3 net premium credit. At $57 the short call costs $7, so the result is 3 minus 7. Above $60 the spread loses $10 less the $3 credit.

  1. AProfit of -$4.00; maximum loss $7.00Correct
  2. BProfit of -$4.00; maximum loss $10.00
  3. CProfit of $3.00; maximum loss $7.00
  4. DProfit of -$7.00; maximum loss $7.00

Explanation

Net premium received is 5 - 2 = $3. At S = 57 the short call costs 7 and the long call pays 0, so the net is 3 - 7 = -$4. Maximum loss occurs at S at or above 60: the spread loses 10 on payoffs, offset by the $3 credit, giving $7. A $10 loss ignores the premium credit, and -$7 omits it from the profit calculation.

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