4. If you wanted to purchase the right to sell 2,000 shares of J.C. Penny stock

Question

4. If you wanted to purchase the right to sell 2,000 shares of J.C. Penny stock in August 2008 at a strike price of $45 per share. Suppose J.C. Penny stock sells for $36.50 per share immediately before your options' expiration. What is the rate of return on your investment? What is your rate of return if the stock sells for $52.50 per share? Assume your holding period for this investment is exactly four months. Put Options (Expire at close Friday, August 15, 2008) Strike Symbol Last Chg Bid Ask Vol Open Int 45.00 JCPTI.X 6.70 0.00 6.80 7.00 10 10

Explanation / Answer

The ask price is $7. This is the amount needed to purchase put option on one share.

So assume, investment is $7.

If stock price is $36.5, put option is in the money, and the payoff is 45-36.5 = 8.5

So return = (8.5-7)/7 =0.2142 = 21.42% for 4 months = 64.28% p.a.

If stock price is $36.5, put option is out of the money, and the payoff is 0

So return is 0%

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