Suppose the following options (on a stock) with three-months to maturity are traded on the market. The underlying stock is currently traded at $50 per share.

Option Type Strike Price Premium

Call $50 $5

Call $55 $2

Put $48 $4

Put $45 $2

a) Construct a bear spread. Present your strategy with a profit diagram and a payoff table. What would your profit be if the stock price declines to $45 in three months time? (13 marks)

b) Construct a bull spread. Present your strategy with a profit diagram and a payoff table. What would your profit be if the stock price declines to $45 in three months time?