Question

3) You have the potential option to write a put contract with a strike price of $35.00 with a expiration day that is in 6 months. This particular contract is for 100 SH's for the put option. You receive $2.75 per share for writing the put contract.

A) What is the maximum gain/profits($) from potentially writing the put option contract?

B) What is your maximum loss potential loss ($) resulting from writing this contract?

Answer 1

A put option is an option to sell the underlying asset at the strike price on maturity. When you write or sell a put option, you are selling someone else the option the sell the underlying asset to you at the strike price on maturity. Lets say you sell the put option to "A". Now, A has the option to sell the 100 shares to you @$35 on maturity date. When you sell the option you receive the option premium of $2.75 per share.

A) In the above example, A will sell this option to you only in case the actual stock price is less than the strike price, so that A buys the 100 shares from the market at lower than strike price and sells to you @$35. Now, you receive 100 shares from A and then sell it on the market at a lower price. So, you will have a loss in any case if A decides to exercise the option. Therefore, Maximum gain will occur only if A does not exercise the option and the gain in that case would be the premium received.

Maximum Gain = Option premium = $2.75 x 100 = $275

B) Maximum potential loss would be when the actual market price of the shares is $0. In that case you purchase from A @$35 but sell@$35 minus premium received on selling the option to A.

Maximum Loss = ($35 x 100) - $275 = $3225