Question

An investor sells a European put on a share for $8. The current stock price is $57 and the strike price is $60. (a) Under what circumstances will the investor make a profit (have positive profit) on the expiration date? (b) Under what circumstances will the option be exercised on the expiration date? (c) Please draw a diagram showing how the investor’s profit depends on the stock price on the expiration date. To put it another, draw a diagram showing the relationship between the investor’s profit and the stock price on the expiration date.

Answer 1

a) an investor will be in profit, as long the expiry price is above $ 52

Break even for Short Put   = strike price - premium collected

                                        = 60   -8   = $ 52

as far as the stock price is above $52, the investor will make profit .

pay off for short put is = initial option price – MAX ( 0 , strike price – underlying price )

b)   the option will get exercised when the underlying price on expiry falls below the strike price of $60.when the expiry price is below $ 60- the option will have an intrinsic value and is likely to be exercised by the buyer of such options

c) pay off diagram for short put option is