An investor has ashort position inEuropean put on a share for 4$. The stock price is...

An investor has ashort position inEuropean put on a share for 4$. The stock price is $40 and the strike price is $42
(a) Under what circumestances will the option be exercised?
(b) Under what circumstance does the investor make aprofite?
(c)Draw apayoff diagram plotting the investor's payoff as afunction ofST.
(Draw aprofit diagram plotting the investor's profit as a function of ST

(e)Suppose now the investor enters also into a long position of put option with strike price $39 . This put is on of the same underlying and has the same maturity time.
Describe the total pay off to the trader via a payoff tabel or payoff diagram.

Expert Solution

a) As the Investor has the short position on Put which means somebody has bought the Put option. The option will be exercised in the circumstances in which the stock price will be less than Strike price. In current scenario the stock price is $40 but the strike prcie is $42, so the trade will be profitable for the other investor if he exercises the option now because he has the right to sell at a price of $42 which $2 more than the current stock price.

b) The Investor will make profit if the stock price goes above the strike price. In that case the investor who is long on Put option will not exercise the option as a result option writer will make a profit to the extent of premium received.

jeff jeffy answered 1 year ago

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