Question of the Week

Just prior to the close of the markets on the final trading day before expiration in February, PDQ stock is trading at 28. Both contracts are closed by the investor. What will be the profit or loss from these transactions?

Write 1 PDQ Feb 30 Put @ 3
Long 1 PDQ Feb 40 Put @ 9

a) $600 loss
b) $1,200 loss
c) $1,200 profit
d) $400 profit

Answer:

The correct answer is d.

The investor opened the spread strategy with a net debit of $600. When he/she closes the 40 call (by selling) the intrinsic value is 12 points (40 – 28 = 12). When he/she closes the 30 call (by buying it back), the intrinsic value is 2 (30 – 28 = 2). Netting out the closing transactions, the investor sold for 12 and bought for 2 (12 – 2 = 10). The investor closed for a net of +10 but had a -6 to open the spread (10 – 6 = 4, or $400).