You write a put with a strike price of $50 on stock that you have shorted at $50
ID: 2763047 • Letter: Y
Question
You write a put with a strike price of $50 on stock that you have shorted at $50 (this is a “covered put”). What are the expiration date profits to this position for stock prices of $40, $45, $50, $55, and $60 if the put premium is $2.30? (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$" sign in your response.)
Stock Price Short Profit Short Put Payoff Short Put Profit Net Profit $40.00 $45.00 $50.00 $55.00 $60.00Explanation / Answer
Solution:
Writer of Option is the seller of Option.
Write of Put Option is the Seller of Put Option – Seller of Put Option has an obligation to buy share at Strike Price on expiration of put option.
Seller of Put Option is received put premium when he write/sell the put option.
On exercise date
-- If price of a share is higher than exercise price (in this case $50) then buyer does not exercise his right and he loss premium amount and seller gain premium amount.
-- If price of a share is less than exercise price then buyer will exercise his right and seller is bound to buy share at exercise price even actual market is less.
Calculation of Net Profit /(Loss) to writer of a put option
Exercise Price
Stock Price
Premium Received
Remark
Pay off Put
Net Profit
$50
$40.00
$2.30
EP > SP --- buyer will exercise option
($10.00)
($7.70)
$50
$45.00
$2.30
EP > SP --- buyer will exercise option
($5.00)
($2.70)
$50
$50.00
$2.30
EP = SP --- buyer may / may not exercise option
$0.00
$2.30
$50
$55.00
$2.30
EP < SP --- buyer will not exercise option
$5.00
$7.30
$50
$60.00
$2.30
EP < SP --- buyer will not exercise option
$10.00
$12.30
For understanding
-- When Stock Price is less than Exercise Price --- Buyer will exercise option because he has the right to sell at exercise price and earn benefit by selling share at $50 whereas the actual stock price is $40. Profit for Buyer by exercising the put option is $10 (Exercise Price – Actual Stock Price) and the net profit will be $7.70 ($10 benefit minus premium paid for purchasing put option). Profit of Buyer is the loss to seller of put option.
-- When Stock price is higher than Exercise Price --- Buyer will not exercise option because buyer can sell share in market at higher price than exercise price and earn profit, then why he buy at lower price.
Calculation of Net Profit /(Loss) to writer of a put option
Exercise Price
Stock Price
Premium Received
Remark
Pay off Put
Net Profit
$50
$40.00
$2.30
EP > SP --- buyer will exercise option
($10.00)
($7.70)
$50
$45.00
$2.30
EP > SP --- buyer will exercise option
($5.00)
($2.70)
$50
$50.00
$2.30
EP = SP --- buyer may / may not exercise option
$0.00
$2.30
$50
$55.00
$2.30
EP < SP --- buyer will not exercise option
$5.00
$7.30
$50
$60.00
$2.30
EP < SP --- buyer will not exercise option
$10.00
$12.30
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