Screencast 3.b Pg 11

[rajaar]

Dear David,

There is a long call and short call in this example which cancel out returns in any situation. The only difference is in the premiums and the strike prices for the two call options. So what is meant when you say that these offer very high returns on initial investment

Regards
R

 

[David Harper CFA FRM]

Hi R,

That illusrates the bull spread, per the example:
long call (strike = $20, premium = $1.99) + short call at higher strike (strike = $23, premium = $0.83)
i.e., strike on short > strike on long

so the initial cost (net debit) = $1.99 paid for long - $0.83 received for short = $1.16 which, in the bull spread, is also the maximum loss
the maximum gain = ($23 - $20) - $1.16 = $1.84
so the potential ROI = $1.84/$1.16 = 158%

David