A bull spread, or split strike conversion, strategy has the following components.

Buy a security at price S. Buy one share of the stock.

Buy an out of the money (OTM) put option at strike price K1 where K1 < S.

Sell an OTM call option at strike price K2 where K2 > S.

Invest the difference between the call and put premiums at the risk free rate.

Assume that a stock has price S=$20. There is a 10% OTM put option with a strike price of$18and a put premium (cost) of $1.00. There is also a 10% OTM call option with a strike price of$22and a call premium (cost) of $1.10. Both options expire in 1 month. The risk free rate is 4% annually.

a). Describe the cash flows at time 0, when you initiate the trade.

b) Assume that the stock loses 4% for the first month. What is your portfolio worth? Explain each position's value in detail and state the ending value of the portfolio

c) What is your rate of return at the end of the first month?