Question

In: Finance

1. Explain why the following statement is true or false. 1)“A put seller is at risk...

1. Explain why the following statement is true or false.

1)“A put seller is at risk of losing money if the underlying price increases.”

2)“A call seller is obliged to buy the underlying share at the exercise price.”

2. What is the maximum profit potential if you long a call or put option?

Solutions

Expert Solution

1. a. True.

A put seller is the one who writes the option to a put buyer. A put buyer makes money if the underlying price decreases below strike price. On contrary, put seller losses money if underlying price increases.

b. False

A call buyer will have right to buy the option but not the obligation. To contrary, call seller will have obligation to sell the option, not to buy

2. Unlimited profit potential for a long call option holder.

Maximum profit=share price-srike price-call premium

The increase in the share price is unlimited, hence the maximum profit is unlimited

For put option, the maximum profit=strike price-share price-put premium

Here the maximum share price can go up to 0.

Hence, the profit is limited.


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