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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

An investor creates a bull call spread on Nifty-linked stock X: buys a Rs 500 call at premium Rs 35 and sells a Rs 540 call at premium Rs 15, same expiry, per share. At expiry X trades at Rs 560. What is the net profit per share, and what is the maximum possible profit?

Net profit is Rs 20 per share and this is also the maximum. The spread payoff is capped at the Rs 40 strike difference, and the net premium paid of Rs 20 must be deducted, so profit cannot exceed Rs 20 whatever the price rise.

  1. AProfit Rs 40; maximum Rs 40
  2. BProfit Rs 20; maximum Rs 20Correct
  3. CProfit Rs 20; maximum Rs 40
  4. DProfit Rs 60; maximum Rs 20

Explanation

Net premium paid = 35 - 15 = Rs 20. At Rs 560 the long call is worth 60 and the short call costs 20, a spread payoff of 40 (capped at the strike difference of 40). Net profit = 40 - 20 = Rs 20, which is also the maximum, since payoff is capped at 40. Rs 40 ignores the net premium.

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