Question

risk free interest rate = 0.08
price of stock at expiration = St
St is unknown quantity, st > 0
one contract = 100 share
1. we implement bull put at strike price 47.5 and 42.5 on a stock, receving a net payment or 1.45 on this transaction
a. is this buy or selling, call or puts, and which strike price in each case?
b. what is the max value profit for one contract? ( T=1/4 (3 months) ) explain the reasoning
c. suppose that at expiration ( 3 month) , stock price is 45. what is the value of the profir expressed as real number ( positive, negative or zero) for this transaction for one contract? explain the reasoning

Answer 1

Part A :

In a bull put strategy the investor both buys and sells a put option. The put option is bought at a lower strike where the put option is sold at a higher strike.

The payoff diagram for the above mentioned bull put strategy is shown below:

Thus put option bought at 42.5 and sold at 47.5.

Part b

The maximum profit from one option is 1.45 and thus for a lot of 100 stocks it is 145$.

This is so because as seen in diagram we are only in profit if stock price ends up higher than 47.5 . If stock price is higher then 47.5 no put is excercised and we make 1.45 what we intially got.

Part C

If at the end of three month stock price is 45.

The put that we sold at 47.5 will be excercised and we will lose 2.5 $ per stock on that.

The put that we bought at 42.5 is worthless.

Thus in the nutshell we end up losing

= 2.5 - 1.45 = 1.05 $ loss

thus, Loss on whole contract is 105$