Answer: Bear spread, with maximum profit of USD 8, and maximum loss of USD 2

ExplanationA is correct. This strategy of buying a call option at a higher strike price and selling a call option on the same security with the same maturity at a lower strike price is known as a bear spread. To establish a bull spread, one would buy a call option at a lower strike price and sell a call option on the same security with the same maturity at a higher strike price. The cost of the bear spread strategy will be: USD -10 + USD 2 = UsD -8 (a negative cost, which represents an inflow of USD 8 to the investor) The maximum payoff occurs when the stock price ST ≤ USD 50 and is equal to USD 8 (the cash inflow from establishing the position) as none of the options will be exercised. The maximum loss occurs when the stock price ST ≥ USD 60 at expiration, as both options will be exercised. The investor would then be forced to sell XYZ shares at USD 50 to meet the obligations on the call option sold, but could exercise the second call to buy the shares back at USD 60 for a loss of USD -10. However, since the investor received an inflow of UsD 8 by establishing the strategy, the total profit would be USD 8 - USD 10 = USD -2 When the stock price is USD 50 < ST ≤ USD 60, only the call option sold by the investor would be exercised, hence the payoff will be 50 - ST. Since the inflow from establishing the original strategy was UsD 8, the net profit will be 58 - ST, which would always be higher than USD -2. B is incorrect. The maximum profit of the bear spread is USD 8 (earned when neither option is exercised). C is incorrect. The strategy is a bear spread. D is incorrect. The strategy is a bear spread, and its maximum loss is USD 2 (incurred when both options are exercised).

Author: LeetQuiz Editorial Team