Question

EXERCISE #1: Options basics. Figure out the payoff and the profit per share in A-C: A. You sell a 47 put for 4. Stock ends at $48.

Payoff=................ Profit=............................ B. You sell a 54 put for 4. Stock ends at $47.

Payoff=................. Profit=.......................... C. You sell a 50 put for 3, and buy a 45 put for 2. Stock ends at $45.

Payoff=................ Profit=............................ D. You buy a 52 put when the stock trades at 49.

Intrinsic Value= ............. Premium > .........................

Answer 1

A.

Put with strike price of $47 is sold for $4.

Stock ends at $48

Payoff = Max (0, strike price -spot at expiry)

Payoff = Max (0, 47-48)

Payoff = 0

Profit = Premium Received - Payoff

Profit = 4-0

Profit = $4

B.

Put with strike price of $54 is sold for $4.

Stock ends at $47

Payoff = Max (0, strike price -spot at expiry)

Payoff = Max (0, 54-47)

Payoff = 7

Profit = Premium Received - Payoff

Profit = 4-7

Profit = (-$3) {i.e. loss of $3}

C.

Put with strike price of $50 is sold for $3.

Put with strike price of $45 is bought for $2.

Net Premium received = $3 - $2 = $1

Stock ends at $45

Payoff of $50 put option sold = Max (0, strike price -spot at expiry)

Payoff of $50 put option sold = Max (0, 50-45)

Payoff of $50 put option sold = $5

Payoff of $45 put option bought = Max (0, strike price -spot at expiry)

Payoff of $45 put option bought = Max (0, 45-45)

Payoff of $45 put option bought = $0

Profit = Net Premium Received - Payoff payable from put option sold + payoff receivable from put option bought

Profit = $1 - $5 + $0

Profit = (-$4) {i.e. loss of $4}

D.

Bought a 52 put when the stock trades at 49.

Intrinsic value of option is value of option if excercised immediately.

Therefore in above case, instrinsic value of option is $3.

Premium > .........................

Premium is greater than intrinsic value of option

Therefore, Premium > $3