Page 91 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes Maximum Loss: Limited to the difference between the two strikes minus the net premium.
Maximum Gain: Limited to the net premium received for the position i.e., the premium
received for the short call minus the premium paid for the long call.

When to use: When we are mildly bearish on market direction.
4. Put Bear Spread: This is formed by short one put option at a lower strike price and long
one put option at a higher strike price. A Put Bear Spread has the same payoff as the Call
Bear Spread as both strategies hope for a decrease in market prices. The choice as to which
spread to use, however, comes down to risk/reward. A good tip is to compare the market
prices of both spreads to determine which has the better payoff for us. The pay-off for put
bear spread is depicted in Figure 7.11.

Figure 7.11: Profit/Loss at Expiration for Put Bear Spread

Maximum Loss: Limited to the net amount paid for the spread. i.e. the premium paid for the
long position less the premium received for the short position.
Maximum Gain: Limited to the difference between the two strike prices minus the net paid
for the position.
When to use: When we are bearish on market direction.
The basic features of Bear Put Spread are as follows:

(a) Bear Put Spread is created by buying a put option at a particular strike price and
simultaneously selling a put option with a lower strike price within the same contract
month.

(b) A Bear Put Spread should be used when the marketer is bearish on a market down to
a certain point. The strike price of the sold put option should be below a known
support plane on the associated futures chart.
(c) Speaking strictly of the spread strategy, there are limited losses and gains. The loss
is limited to the initial cost of creating the position (premium of the purchased put
option minus the premium of the sold put option plus commission costs). The
spread gain is limited to the difference between the strike price of the put option
purchased and the strike price of the put option sold minus commissions and the net
premium paid.

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