A call option on an S&P 500 futures contract has an exercise price of 1490; the

Question

A call option on an S&P 500 futures contract has an exercise price of 1490; the call premium is currently $6.50. On the same date, a put option on the S&P 500 futures contract has an exercise price of 1490; the put premium is currently $7.50. The two options have the same expiration date.

Assume that the S&P 500 index is 1485 at expiration:

A) Should the call option be exercised or should it be left to expire? What is the net ($) gain or loss after accounting for the premium paid to purchase the option?

B) Should the put option be exercised or should it be left to expire? What is the net ($) gain or loss after accounting for the premium paid to purchase the option?

Explanation / Answer

a. exercise price of call option = 1490. premium = $6.50. effective buying price = 1490+6.5 = 1496.50

s&p 500 index at the time of expiration = 1485. so, if the call option is exercised, you will have to pay more (1490) than the index at the time of expiration (1485). So the call option should be left to expire.

net loss = effective purchase price - index at expiration = 1496.50 - 1485 = $11.50

b. exercise price of put option = 1490. premium = $7.50. effective selling price = 1490-7.5 = 1482.5

s&p 500 index at the time of expiration = 1485. so if the put option is exercised, you will get more (1490) at the time of expiration than the index at the time of expiration (1485). so put option should be exercised.

net loss = gain from put option - premium. gain = 1490 - 1485 = 5. premium = 7.5.

so, net loss = 5-7.5 = -$2.5

(Note: if the put option was left to expire, your loss would be the premium already paid i.e $7.50. By exercising the put option, you are reducing your loss).

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