5. Suppose a spot price of a market index is $1000. After 6 months the market...

5. Suppose a spot price of a market index is $1000. After 6 months the market index is priced at 1020. The annual risk-free rate is 5%. The premium on the short put, with exercise price of 1050 is $10.

a. What is the profit at expiration for a short put? [4]

b. What is the intrinsic value of the short put in (i) above? [2]

Solutions

Expert Solution

Answer a.

A short put occurs if a trade is opened by selling a put. For this the seller receives a premium for sell an option. The writer's profit on the option is limited to that premium received.

If a trader initiates a short put, they believe that the price of the underlying stock will stay above the strike price of the written put. If the price of the underlying stays above the strike price of the put option, the option will expire worthless and the writer gets to keep the premium. If the price of the underlying falls below the strike price, the seller faces potential losses.

In this case the strike price is 1050 for which writer receive $10 as premium.

After 6 months Market index is priscd at $1020.

So the Loss is = Strike price - price at expiration of option- Premium received

Loss= 1050-1020-10= $20

Answer 2

Intrinsic value of put option is the diference between the strike price and the underlying stock price.

In this case

Intrinsic value of option at the time of expiration is = $1050- $1020 =$30.

and

Intrinsic value of option at the time of short the put option: is = $1050-$1000= $50

jeff jeffy answered 1 year ago

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