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CFA Level 3
Advanced
1/20
An investor has a moderately bullish outlook on OPQ stock, which is currently trading at $65 per share. The investor believes the stock price will increase in the near future but wants to limit the potential loss if the stock price declines. The investor buys one OPQ 65 call option contract with a strike price of $65 and a premium of $3 per share, and simultaneously sells one OPQ 70 call option contract with a strike price of $70 and a premium of $1 per share. Both options have the same expiration date. What options strategy is the investor implementing, and what is the maximum loss potential of this strategy assuming the stock price drops to $60 at expiration?
a.
The investor is implementing a bull call spread strategy. The maximum loss potential is limited to the net premium paid, which is $2 per share, or $200 per contract (($3 - $1) x 100 shares). This loss occurs if the stock price is at or below the lower strike price of $65 at expiration.
b.
The investor is implementing a bear call spread strategy. The maximum loss potential is the difference between the strike prices minus the net premium received, which is $3 per share, or $300 per contract (($70 - $65) - ($3 - $1)) x 100 shares). This loss occurs if the stock price is at or above the higher strike price of $70 at expiration.
c.
The investor is implementing a long straddle strategy by purchasing both a call and a put option at the same strike price. The maximum loss potential is the total premium paid for both options, which is $4 per share, or $400 per contract (($3 + $1) x 100 shares). This loss occurs if the stock price remains at $65 at expiration.
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