I just did Mark Meldrum’s Mock #3 and I don’t understand the explanation for question 4A in the AM session.
As per the explanation, the investor would choose a bull spread if he believed that the share price would increase but wanted to protect against an unexpected decrease.
Whether a Bull Put Spread or Bull Call Spread is used, I do not understand how the downside is protected.
The only explanation I have come up with is to assume that a put option has been sold…in that case, buying a put option below the short put strike would me the strategy into a Bull Put Spread and the long put would effectively protect the downside.
The downside protection doesnt have to do with the difference between a bull put spread or a bull call spread… they do the same thing (although one is a credit spread and one is a debit spread – they both have known max profits and max loses up front)
I dont have the question in front of me, but in general, the bull spread is used if you think the market is going to go up to a certain degree. It protects your downside because your maximum lose is known – here it is the premium you paid for the spread.
Because the max loss is known and is likely a small amount versus buying the underlying, you are protected against an unexpected decrease, to an extent.
Like I said, I dont have the question so that’s my assumption.