Question

In: Finance

Exercise 1. An investor has a short position in a European put on a share for...

Exercise 1.

An investor has a short position in a European put on a share for $4. The stock price is $40 and the strike price is $41.

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

Solutions

Expert Solution

Put option
Put option provide right but not obligation to sale.
Put writer/ seller Put writer must have to perform or purchase share/ stock on underlying price.
Put holder/purchaser Have right but not obligation to perform.
Investor position
Position Market price < Strike price Market price =Strike price Market price >Strike price
Put holder/purchaser
Profit Strike price-market price- premium paid
Loss Premium paid Premium paid
Put writer/ seller
Profit Premium received Premium received
Loss Strike price-market price- premium received
Payoff table for put holder with strike price =41
Putholder exercise his option only when market price lower than strike price otherwise he has no obligation to perform.
Market Price 1 41 100
Position Market price < Strike price Market price =Strike price Market price >Strike price
Profit calculation 41-1-4 Option will not be exercised.
Profit 36
Loss calculation 41-41-4
Loss -4 -4
Payoff table for put holder with strike price =39
For put writer it is must to perform when prices goes down else option will not be exercised by buyer and writer will receive the premium amount.
Market Price 1 39 100
Position Market price < Strike price Market price =Strike price Market price >Strike price
Profit calculation 39-39-4 Option will not be exercised by buyer.
Profit 4 4
Loss calculation (39-1-4)
Loss -34

jeff jeffy answered 1 year ago
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