Question

1) You buy the stock at a price of $243 and at the same time you buy a put option with an exercise price of $240, paying a premium of $2.

a) What is your total cost at the beginning for buying both the stock and the put option? Consider this as your total wealth. Show your calculations.

b) If the stock price falls to $230 and you exercise the put, what would be your final wealth in this example? Explain.

c) What is your total loss in dollars if the stock price falls to $230 in the market? Show your calculations and explain.

d) What is your maximum total loss if the stock price goes down to zero? Show your calculations and Explain

Thanks for your help. :)

Answer 1

A) Total cost at the beginnign = Purchase price + Option premium = 243+2 = $245

B) If the stock price falls to $230, option will be exercised and @$240. Thus, Total wealth will become 240. Loss of $5 from initial position.

C) Total loss in dollars would be of $5. Loss = Wealth at beginning - wealth after exercising option = 245-240 = $5

D) Even if stock goes down to Zero, the maximum loss would be $5 only as the person can exercise the option of selling the share @$240. Hence wealth can't go below 240. Loss cannot be more than 245-240 = $5