Suppose it is September and a speculator consider that a stock is likely to decrease in...

Suppose it is September and a speculator consider that a stock is likely to decrease in value over the next three months. The stock price is currently $100, and a three-month put option with a strike price of $99 is currently selling for $5.00 per share. • create a table which compares selling short 2000 shares of stock and buying a put option written on 2000 shares of stock. Use December stock prices of $85 and $115.

Expert Solution

Case 1 > Short selling 2000 shares of stock today and comparing the profit/loss in the two scenarios of the three month price of the stock - $85 & $115:

Cost Price = $100

Additional cost = 0 (assuming 0 transaction and brokerage charges)

Break-even price per share = $100

Break-even price for 2000 shares = $100 * 2000 = $200000

Price Per share Profit / Loss (indicated by +/- signs)

85 200000-85*2000 = +30000

115 200000-115*2000 = -30000

Case 2 > Purchasing 2000 put options of stock today (assuming 1 lot of option consist of 1 unit of shares of the stock since no data is given) and comparing the profit/loss in the two scenarios of the three month price of the stock - $85 & $115:

Cost Price = $5 * 2000 = $10000

Additional cost = 0 (assuming 0 transaction and brokerage charges)

Break-even price per share = strike price - option premium = $99 - $5= $94

Price Per share Profit / Loss (indicated by +/- signs)

85 (99 - 85)*2000 - 10000 = $18000

115 -$10000 ((99 - 115)*2000 - 10000 = -$42,000, since the maximum loss in buying a put option is its paid premium)

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