You purchase one IBM October 160 put contract for a premium of $5.35. What is yo

Question

You purchase one IBM October 160 put contract for a premium of $5.35. What is your maximum possible profit? (See Figure 15.1.) Assume each contract is for 100 units.

PLEASE SHOW ALL STEPS, THANK YOU!

Potential Profit= $??

FIGURE 15.1 IBM IBM) Undelyingstock prke: 166.76 Options on IBM, August 24, 2011 Soure: Te Wall Street Jonal Cnlns August 25, 2011 Reprinted by permission of The Wll &treet; Journal Copyright© 2011 Dow Jones & Compary, Irr. All Rights Reserved Worldwide. Call Put n Interest Expiration Strike ep 2011 Oct 2011 Last Volume 796 301 101 1835 2.62 2369535 7890 9.40 ast VolumeOpen Interest 4298 7443 4920 160.00 9.15 160.00 11.95 Jan 2012 160.00 15.00 Apr 2012 160.007.35 5.80 8. 70 Jan 201 2 165.00 11.70 Apr 2012 165.0014.30 1271 296 102 122 13.30 3542 4.10 3866 7.00 4045 10.85 1805 329 93 58 3.00 3053 457 73 36 5085 2651 4466 54 12436 4584 2929 52 ep 2011 165.00 165.00 131 303 Oct 2011 781 5.86 8.93 Apr 2012 170.00 11.32 Sep 2011 Oct 2011 Jan 2012 170.00 170.00 170.00 7506 9.25 6876 13.00 79596.20 2744 148 58 58

Explanation / Answer

Since, you purchased the put option, you expect the stock to move down. Payoff of the put option is mathematically expressed as:

Payoff of Put = Maximum (0, Exercise Price - Stock Price) - Put Premium

This implies, the investor or long in put option is profitable when the the stock price moves below the exercise price. Maximum loss incurred would be the premium paid on the put option.

Now, in our question, Exercise price is $160.

The stock is currently trading at $166.76. Investor would profit when the stock price moves below $160. Lower the stock price moves beow $160, higher would be the profit.

Lowest stock price possible = $0.

So maximum profit possible can be calculated by putting this in payoff equation,

Payoff for put = [Maximum (0, 160 - 0) * 100] - 5.35 = 15,994.65 --> Answer

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