Question

QUESTION 41

1. On April 10, 2016, Samuel Jackson, CFA purchased a put option for 2,000 shares of Apple at $4.00 per share. Jackson paid $350 for the option that is exercisable until May 10, 2016. On May 10, when Apple stocks were selling at $3.60, Jackson exercised the option. Which of the following statements is false?

	a.	The option should be exercised to earn payoff of 800.
	b.	The option should not be exercised for there will be a loss.
	c.	The option should be exercised to earn a profit of 450.

Answer 1

Let us first understand, what it means to be a PUT OPTION BUYER.

Put Options mean giving the buyer of the option, the right but not the obligation to sell the required shares. (Right to sell)

The Put Seller/Writer will have the obligation to buy.

The Put buyer will expect the price to decrease because he has the option of selling the required shares to the Put Seller and the Put Seller will be under obligation to buy it.

In the above question,

The Market Price at $3.60 is less than the Strike Price of $4.00. If the Put Buyer exercises its right, then the Put Seller will have to buy the Shares from the Put Buyer at a higher price of $4.00 even though the shares are available in the Market at a price of $3.60.

The payoff is the difference between the Strike Price and the Market Price.

So, payoff under this case will be

So, Statement a above is correct.

Profit under Put Option is calculated as follows

When Market price < Strike Price, he will exercise his option.

Profit = Strike Price - Current Market Price - Premium.

When Market price > Strike Price, he will not exercise his option.

Loss = Amount of premium paid

Profit under this case = 8000 - 7200- 350 = 450

Statement c is Correct

It can be said that Statement b is incorrect because there is a profit