Question

Six months ago, you went long on put options, which expire in exactly 12 months from purchase. The strike price is $110. The Spot price today was $122.18 at close of after-hours trading. You paid $8.00 for each option.

A. If you choose to exercise before markets close today, what is your payoff?

B. If you choose to exercise before markets close today, what is your profit?

Answer 1

Put option: It is the type of option where buyer of the option buy the right to sell, it means the person buying the put option will get the right to sell the option. The buyer of put option is not obliged to exercise the option. He will exercise the put option only when the Market Price< Strike/exercise price.If he exercises his option he would be able to sell at higher exercise price and buy at lower market price, thus gaining from the stock deal.

The above gain will be gross gain. The net gain will be Groff gain- Premium paid.

Terms:

Long: To Buy

Short: To Sell

In the question you went long it means you bought put option i.e Right to sell.

Given:

Strike Price: $110

Spot price: $122.18

Option Premium: $8

Solution to Point A:

Payoff are of 2 types viz:

Gross Payoff: It means amount received by the put option buyer on the exercise of option.

Net payoff: It means Gross payoff less premium paid.

So in our question

Gross payoff will be: Amount received on exercise of option i.e $110

Net Payoff will be : Gross payoff less Premium paid i.e $110-$8 = $102

Solution to Point B:

As clarified above buyer of the put option will be benefitted only when Spot price < Strike Price.But in our question Spot price > Strike Price ($122.18 > $110).It means if option is exercised then there will be loss to put option buyer.

Loss = Spot Price - Net payoff

Loss = $122.18 - $102

Loss = $20.18

Hence there will be no profit if you choose to exercise before market closes today, rather there will be loss of $20.18 as calculated above.