Question

An investor owns 5,000 shares of stock AB, which is currently trading at $100 per share. The investor is fearful of a sharp decrease of the stock price. He decides to buy 50 December 92 put option at a price of $3, paying $15,000. Note: Each put option contract provides for the right to sell 100 shares of stock. December 92 put option means that the strike price of the put is 92 and it matures in December.

If IBM stock price rises from $100 to $110, the profit associated with the passive strategy is_____ and the profit associated with the protective put strategy is____.

	A.	$50,000, $25,000
	B.	$50,000, $65,000
	C.	$50,000, $15,000
	D.	$50,000, $35,000

Answer 1

A protective put strategy is to buy the underlying stock and buy the put option by paying premium.

Purchase price of stock AB = $100

Strike price of put option = $92

Put option premium = $3

Total put option premium = Put option price * Number of put option contracts * Number of underlying shares per contract

Total put option premium = 3 * 50 * 100 = $15,000

Stock price at expiry, St = $110

If St = 110,The profit associated with the passive strategy = (St - purchase price)*Number of shares

The profit associated with the passive strategy = (110 - 100) * 5,000

The profit associated with the passive strategy = $50,000

The profit associated with the protective put strategy = The profit associated with the passive strategy - Total put option premium

The profit associated with the protective put strategy = 50,000 - 15,000

The profit associated with the protective put strategy = $35,000

The correct answer is option D. $50,000, $35,000