Question

You bought 100 Google Shares for $400 each. You also bought 1 put option on Google with a strike of $395 for $20.

a)         What is the maximum loss on your position?

b)         What is the profit on your position when the stock hits $440?

c)        Draw the profit/loss diagram for this position clearly marking the maximum loss, and breakeven

Answer 1

a) The maximum loss on this position occurs when the stock price drops below the breakeven price.

Breakeven price = Stock purchase price + Put option price

Breakeven price = 400 + 20 = $420

Max loss price <= Strike price <=$395

When the stock price drops below $395, the loss from the long shares = 100 * (400 - 395) = $500

The maximum loss on the put option = premium paid * 100 = 20 * 100 = $2,000

Total maximum loss = 500 + 2,000 = $2,500

b) Profit on long stock = (440 - 400) * 100 = $4,000

Profit on long put option = max(395 - 440, 0) - 20 = -20 per share or -20 * 100 = -$2,000 per contract

Profit of the position = 4,000 - 2,000 = $2,000

c) Maximum loss = $2,500 when St <= 395

Breakeven price = $420

Screenshot with formulas