Question

Suppose that a June put option on a stock with a strike price of $60 costs $4 and is held until June. Under what circumstances will the holder of the option make a gain? Under what circumstances will the option be exercised? Draw a diagram showing how the profit on a short position in the option depends on the stock price at the maturity of the option.

**Can you please explain step by step on how to do this question*** and please show formulas used so I can understand how to do it on my own. thank you.

Answer 1

1. Put Option It means a right to Sell the Share.

2. Put Option Shall be exercised when the market Price of Stock on exercise date is below the Strike Price

3. So here the maximum loss is the Option cost i.e should be paid even when option lapses = $ 4

4. So the Stock Price on which profit can be made i.e OPTION CAN BE EXERCISED when it is lower than $ 60 - $ 4 = $ 56

5. Say on Maturity of Option, if Stock Price is Below $ 56 say $ 55, Option Shall be Exercised

Profit = Strike Price - Stock Price - Option Cost

= $ 60 -55 - 4

= $ 1

If Price is above or equal to $ 56 , say $ 56 Option lapses

Profit / Loss = $ 60 - 56 -4

= 0

If Price is above or equal to $ 60 , say $ 60 Option lapses

Profit / Loss = $ 60-60-4 = Loss = -$4

Find Chart Below