You have purchased a put option on Kimberly Clark common stock. The option has a

Question

You have purchased a put option on Kimberly Clark common stock. The option has an exercise price of $81 and Kimberly Clark’s stock currently trades at $82.18. The option premium is $1.46 per contract. Assume that 100 shares are traded. a. Calculate your net profit on the option if Kimberly Clark’s stock price falls to $79 and you exercise the option. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations.) Net profit $ b. Calculate your net profit on the option if Kimberly Clark’s stock price does not change over the life of the option. (Negative amount should be indicated by a minus sign.) Net profit $

Explanation / Answer

A put option provides the buyer the right to sell underlying stock at the Exercise Price.

Here, Exercise Price of Put Option on Stock = $81

Also, Option Premium Paid = $1.46

Solution:

a) If the stock price falls to $79, the buyer will exercise the option and sell the stock at $81 making a gross profit of 81-79 = $2 per share. However, he has also paid a premium of $1.46 towards purcahse of the put option.

Therefore, net profit from the trade = $2-$1.46 = $0.54 per share

For 100 shares, total net profit = 100*0.54 = $54

b) The current trading price of Kimberly's stock is $82.18. If the price does not change over the life of option, the buyer will simply not exercise the option (since exercise price is lower than trading price) and let it expire.

However, he had still paid the option premium of $1.46 and his total loss is therefore -$1.46 * 100 = - $146 for 100 shares

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