Explanation:
Olivia is building a bear put spread, which is created by:
She buys the $52 put for $4.07. To make the spread break even at $50, her net premium outlay must be:
$52.00 - $50.00 = $2.00So the written option must bring in:
$4.07 - $2.00 = $2.07The option that matches this is:
$47.50 and premium $2.07That gives a net cost of $2.00 and therefore a break-even stock price of $50.00 at expiration.
So the correct answer is B.
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Q-727.2. Her erstwhile favorite stock is currently trading at $52.00, but Olivia is now bearish on the stock's prospects. She wants to buy a European put option on the stock with a strike at $52.00 at a cost of $4.07. However, she worries the initial cash outlay on this trade is too high, so she wants to fund this view by ADDITIONALLY writing an option; in this way, her intention is to implement a bear spread. Further, while the long put by itself returns a break-even profit if the stock drops (at the time of option's expiration of course) to $47.93 because $52.00 - $4.07 = $47.93, she wants the bear spread strategy to achieve break-even if the stock drops (at the option's expiration) to $50.00.
Assuming that each of the following option prices is correct (indeed these options are correctly priced under an assumption of 40.0% volatility, one year time to expiration and riskfree rate of 1.0%), which additional trade will complete Olivia's intention for a bear spread?
A
Write a call with a strike price of $47.50 and a premium of $6.69
B
Write a put with a strike price of $47.50 and a premium of $2.07
C
Write a put with a strike price of $49.00 and a premium of $2.65
D
Write a put with a strike price of $57.50 and a premium of $7.54