5. A put option in finance allows you to sell a share of stock in the future at

Question

5. A put option in finance allows you to sell a share of stock in the future at a given price. There are different types of put options. A European put option allows you to sell a share of stock at a given price (called the exercise price) at a particular point in time after the purchase of the option. For example, suppose you purchase an eight-month European put option for a share of stock with an exercise price of $29. If eight months later, the stock price per share is $29 or more, the option has no value. If in six months time the stock price is lower than $29 per share, then you can purchase the stock and immediately sell it at the higher exercise price of $29. If the price per share in eight months is $26.4, you can purchase a share of the stock for $26.4 and then use the put option to immediately sell the share for $29. Your profit would be the difference, $29-$26.4 = $2.6 per share, less the cost of the option. If you paid $1.5 per put option, then your profit would be $2.6-$1.5=$1.1 per share. a) Build a model to calculate the profit of this European put option. b) Construct a data table that shows the profit per share for a share price in eight months between $15 and $35 per share in increments of $1.

Explanation / Answer

a. Put Option Payoff = Strike price - Cost - share price

b. Data Table

STOCK PRICE EXERCISE PRICE COST PROFIT (EX PRICE - STOCK PRICE-COST) 15 29 1.5 12.5 16 29 1.5 11.5 17 29 1.5 10.5 18 29 1.5 9.5 19 29 1.5 8.5 20 29 1.5 7.5 21 29 1.5 6.5 22 29 1.5 5.5 23 29 1.5 4.5 24 29 1.5 3.5 25 29 1.5 2.5 26 29 1.5 1.5 27 29 1.5 0.5 28 29 1.5 -0.5 29 29 1.5 -1.5 30 29 1.5 -2.5 31 29 1.5 -3.5 32 29 1.5 -4.5 33 29 1.5 -5.5 34 29 1.5 -6.5 35 29 1.5 -7.5

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