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CA Final · Advanced Financial Management · Derivatives Analysis and Valuation

Meera constructs a bull call spread on a stock: she buys a call with strike Rs 200 at a premium of Rs 14 and sells a call with strike Rs 220 at a premium of Rs 5. Each lot is 500 shares. Which statement about the spread is correct?

Maximum profit is Rs 5,500 and maximum loss is Rs 4,500 per lot. Net premium is Rs 9 per share, which is the most she can lose; the profit is the Rs 20 strike gap less Rs 9, or Rs 11 per share, times 500 shares.

  1. AMaximum profit Rs 5,500 per lot; maximum loss Rs 4,500 per lotCorrect
  2. BMaximum profit Rs 5,500 per lot; maximum loss Rs 5,500 per lot
  3. CMaximum profit Rs 4,500 per lot; maximum loss Rs 5,500 per lot
  4. DMaximum profit is unlimited; maximum loss Rs 4,500 per lot

Explanation

Net premium paid = 14 - 5 = Rs 9 per share, so maximum loss = 9 x 500 = Rs 4,500. Maximum profit = (220 - 200) - 9 = Rs 11 per share = Rs 5,500. The options that swap the two figures confuse the loss with the profit; unlimited profit applies only to a naked long call.

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