For every question, please write down each main step before you obtain the final
ID: 2618690 • Letter: F
Question
For every question, please write down each main step before you obtain the final answer. Correct final answer with incorrect related work (calculation) or without any work may receive 0 point. On the contrary, incorrect final answer with correct related work (calculation) will receive partial credits.
Question 4 – Put Option [6 points]: Suppose you own a put option that gives you the right to sell 200 shares of MMM Construction to another investor for $25 per share anytime during the next six months. MMM’s stock currently sells for $26 per share.
Should you exercise the option and sell the stock to the option writer (seller) if the stock price stays at $26 per share?
Should you exercise the option if the stock’s price increases to $28? What would be your gain (loss) if you bought the stock at $28 and then exercised the option?
Should you exercise the option if the stock’s price decreases to $23? What would be your gain (loss) if you bought the stock at $23 and then exercised the option?
Explanation / Answer
A put option is the option of lower side. i.e. if the price falls below the exercise price then the difference will be the payoff.
Case 1- Stock price stays at $26.
In this case the option will not be exercise, since the price of stock $26 is higher then the exercise price of $25.If the option is exercised then there will be loss of $200 (200×$1).
Case 2: if the stock price increases to $28, then the option should not be exercised since the price is higher then exercise price.
If the option will be exercised then there will be loss of 200×(28-25) i.e. $600.
Case 3: if the stock price falls to $23.
Yes, the option should be exercised as the price is below the exercised price of $25.
Gain on exercise will be = 200×($25-$23) i.e. $400.
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