Question 9

Assume the options mentioned below are European style, have the same maturity date, and are written on stock MNP. Ignore any discounting between the date at which an option is purchased and the date it matures. Stock MNP costs $30 today.

1. Suppose an investor purchases a bear put spread (i.e. she buys one put option P₁ for $5 with a strike of $35 and sells one put option P₂ for $2 with a strike price of $30). Draw the payoff and profit of the portfolio.
2. What are the advantages and disadvantages of this trade? What do you suppose the investor is trying to do with this trade (i.e. what is her goal)?
3. Give an example of when this trade would be counterproductive (i.e. when would this trade provide payoffs that are opposite the goals of the investor).