EXHIBIT 9.7 ExxonMobil bear put spread.
If the trader is wrong and ExxonMobil is still above 80 at expiry, both
puts expire and the 1.30 premium is lost. If ExxonMobil is between the two
strikes, the 80 puts are ITM, resulting in an exercise, and the 75 puts are
OTM and expire. The net effect is short stock at an effective price of
$78.70. The effective sale price is found by taking the price at which the
short stock is established when the puts are exercised—$80—minus the net
1.30 paid for the spread. This is the spread’s breakeven at expiration.
If the trader is right and ExxonMobil is below both strikes at expiration,
both puts are ITM, and the result is a 3.70 profit and no position. Why a
3.70 profit? The 80 puts are exercised, making the trader short at $80, and
the 75 puts are assigned, so the short is bought back at $75 for a positive
stock scalp of $5. Including the 1.30 debit for the spread in the profit and
loss (P&(L)), the net profit is $3.70 per share when the stock is below both
strikes at expiration.
This is a bearish trade. But is the bear put spread necessarily a better trade
than buying an outright ATM put? No. The at-expiration diagram makes this
clear. Profits are limited to $3.70 per share. This is an important difference.
But because in this particular example, the trader expects the stock to
retrace only to around $75, the benefits of lower cost and lower theta and
vega risk can be well worth the trade-off of limited profit. The trader’s