SECTION THREE

Reem Mohamed Ali

Outline
◦ Bull and Bear Spreads Using Calls

◦ Bull and Bear Spreads Using Puts

◦ Box Spread

◦ Butterfly spread with calls

◦ Butterfly spread with puts

Spreads
◦ A spread is an option strategy where you are simultaneously long and short option of the same type.

◦ Spreads could be bull or bear spreads.

◦ Bull spreads make profit if prices go up.

◦ Bear spreads make profit if prices goes down.

Bull Spread using Calls
◦ The trader hopes to profit from a price rise in the stock.

◦ Requires two calls with the same underlying stock and the same expiration date but with different exercise
prices.

◦ The buyer of a bull spread buys a call with an exercise price below the stock price and sells a call option with
an exercise price above the stock price.
Example :
◦ Assume that the stock trades at $100.

Call option X=95 Premium=$7 Long Position

Call option X=105 Premium= $3 Short Position

The total cost for the bull spread= -7 + 3 = -$4 (Cash Outflow)

ST < 95 ST > 105

Neither of the options will be exercised and both Both options will be exercised.
will expire worthless. As a long, you will exercise your option and buy the
stock at $95.
Profit = -4$ But as a short you will be obligated to sell the stock
at $105.
Profit = 105 – 95 - 4 = $6 (the maximum profit)
Bear Spread using Calls
◦ Requires two calls with the same underlying stock and the same expiration date but with different exercise
prices.

◦ To execute a bear spread with calls, a trader would sell with the lower exercise price and buy the call with the
higher exercise price.

◦ In other words, the bear spread with calls is just the short position to the bull spread with calls.
Example:
◦ Assume that the stock trades at $100.

Call option X=95 Premium=$7 Short Position

Call option X=105 Premium= $3 Long Position

The total cost for the bear spread= 7 - 3 = $4 ( Cash Inflow)

ST < 95 ST > 105

Neither of the options will be exercised and both Both options will be exercised.
will expire worthless. Since ST > 105, the holder of the option will exercise
his option to buy the stock at $95 and you as a writer
Profit = 4$ will be obligated to sell it at $95.
And as a long you have the right to buy the stock at
$105 and you will exercise your option.
Profit = 95 – 105 – 3 +7 = -$6
Bull and Bear Spreads using Calls
Bull Spread using Puts

◦ Requires two puts with the same underlying stock and the same expiration date but with different exercise
prices.

◦ The bull spread consists of buying a put with a lower exercise price and selling a put with a higher exercise
price.
Example :

Put option X=90 Premium=$3 Long Position

Put option X=110 Premium= $9 Short Position

The total cost for the bull spread= 9 - 3 = $6 ( Cash Inflow)

ST < 90 ST > 110

Both options will be exercised. Neither of the options will be exercised and both
As ST < 90, you will exercise your option and sell will expire worthless.
at higher exercise price ($90),
But as a short in a put option with exercise price Profit = 9 - 3 = $6
$110, the holder will exercise his option and as a
writer you will be obligated to buy the stock at
$110
Profit = 90 – 110 – 3 +9 = -$14
Bear Spread using Puts

◦ Requires two puts with the same underlying stock and the same expiration date but with different exercise
prices.

◦ The bear spread trader sells a put with lower exercise price and buys a put with a higher exercise price.
Example :

Put option X=90 Premium=$3 Short Position

Put option X=110 Premium= $9 Long Position

The total cost for the bear spread= -9 + 3 = -$6 ( Cash Outflow)

ST < 90 ST > 110

Both options will be exercised. Neither of the options will be exercised and both
As ST < 90, as a writer of a put option X=90 you will expire worthless.
are obligated to buy the stock at $90 as the holder
will exercise his option. And as a long position in Profit = - 9 + 3 = -$6
a 110 put option , you will choose to exercise and
sell at $110

Profit = 110 – 90 – 9 + 3 = $14

Bull and Bear Spreads using Puts
Summary
Spread Strategies

Bull Spread Bear Spread

Using Calls Using Puts Using Calls Using Puts

The exercise price of the long option is lower The exercise price of the long option is greater
than the exercise price of the short option than the exercise price of the short option
Box Spread
◦ A box spread consists of a bull spread with calls plus a bear spread with puts, with the two spreads having
the same pair of exercise prices.
◦ Bull spread with calls: long 95 call option and short 105 call option.
◦ Bear spread with puts: short 95 put option and long 105 put option.

Stock price Long call Short Put Short call Long Put Total payoff
at expiration X= 95 X= 95 X= 105 X= 105
ST =80 0 -(95-80) = -15 0 (105-80)=25 10

ST = 97 (97-95)=2 0 0 (105-97)=8 10

ST = 102 (102-95)=7 0 0 (105-102)=3 10

ST = 107 (107-95)=12 0 -(107-105)=-2 0 10

The Butterfly Spread
With calls:
The Long trader buys one call with a low exercise price, buys one call with a high exercise price, and sells two
calls with an intermediate exercise price.

With puts:
Long position in a butterfly spread, the trader buys a put with low and high exercise prices and sell two puts
with an intermediate exercise price.
Questions:
1. A bull spread in the options is an option combination designed to profit from falling stock prices. False
2. The bull spread with call options limits the trader's risk but also limits the profit potential. True
3. To execute a bull spread using puts, a trader would sells a put with lower exercise price and buys a put with
higher exercise price. False
4. The buyer of a bear spread buys a call and put option with the same underlying good, expiration date , and
the same exercise price. False
5. Long position in a butterfly spread with puts, the trader buys a put with low and high exercise prices and sell
two puts with an intermediate exercise price. True
Questions:
6. Which of the following positions represents a bull spread?
A. Long 45 call, short 40 call.
B. Long 40 call, short 45 put.
C. Long 40 put, short 45 put.
 Questions:
7. Given the following information. Calculate the profit/loss with bull spread using puts if ST=100. (long 90
put option and short 110 put option )

Put Option X= 90 Premium= $3

Put option X=110 Premium=$9

A. Profit =10
B. Profit = 4
C. Loss = 4

Answer: Profit=0 –(110-100)-3+9 = -$4

Questions:
8. Assume that: S0 = $34.50
Exercise Price Premium
Call Option 35 2.75
Call Option 40 1.55
Put Option 35 3.12
Put Option 40 7.02

The maximum gain with a NOV 35/40 bull call spread is closest to
A. 6.20
B. 3.80
C. 1.20
Thank You