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Create a scenario in which an investor would benefit from using option contracts to minimize risk

Create a scenario in which an investor would benefit from using option contracts to minimize risk

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Expert Solution

Let an investor purchases a stock for $ 100 and put option with a strike price of $100 by paying a premium of $ 5 . Now his profit or loss can be calulated at various prices by using the following formula

Value of Option = If strike price > Market price then Strike price - Market Price, else 0

Profit from the put option = Value of option - Premium paid

Profit from stock = Market Price - Purchase price

Total Profit = Profit from put option - Profit from stock

Value of Put Option
Price of Stock 100
Put Option Premium 5
Exercise Price 100
Price of Stock at the end of expiration period Value of put option Profit on Put Option ( Value - Premium Paid) Profit on Stock Total Profit
70 30 25 -30 -5
75 25 20 -25 -5
80 20 15 -20 -5
85 15 10 -15 -5
90 10 5 -10 -5
95 5 0 -5 -5
100 0 -5 0 -5
105 0 -5 5 0
110 0 -5 10 5
115 0 -5 15 10
120 0 -5 20 15
125 0 -5 25 20
130 0 -5 30 25
135 0 -5 35 30

Thus investor has been able to minimise risk by purchasing a put option. His maximum loss is restricted to $ 5, whereas his profit can be unlimited

His profits and losses can be shown by the following diagram

jeff jeffy answered 2 years ago
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