Question 2 Suppose you have identified two put options on a stock, both having the same expiry dates, but with strike prices K1 = $30 and K2 = $42, and premiums p1 = $4 and p2 = $6 respectively.

a) How would you use these puts to create a bear spread?

b) Construct a table that shows the payoff for each put option, the total payoff and profit for the bear spread.

c) Draw a diagram showing the two put payoffs, and the profits achieved with the bear spread. Make sure you include in your diagram the correct change points at the St prices along the horizontal axis, and the profits () associated with the bear spread along the vertical axis.

d) An investor who constructs a bear spread must have certain expectations about the future behaviour of the underlying assets price. Describe the investors expectations.