Question

# Suppose a student borrows the present value of \$110, buys a 6-month Put option on stock...

Suppose a student borrows the present value of \$110, buys a 6-month Put option on stock Y with an exercise price of \$150, and sells a 6-month Put option on Y with an exercise price of \$40. Draw a position diagram showing the payoffs when the options expire.

6 month option means the option will be exercisedat the end of 6th month.

Put option means right to sell.

Put option holder will get the right to sell the stock. Put option writer will have the obligation to buy the stock when the put option holder exercises his right to sell.

Payoff is the loss or gain to the option owner.

Loss of option holder is limited to premium. Gain is unlimited.

Loss of option writer is unlimited and gain limited to premium.

Position diagram showing payoff is a table showing the payoff.

We need premium to calculate payoff. As not given in the question, i have assumed premium.

*All figures in \$

Payoff of Put option holder (assumed premium as \$20)
CMP EP Action IV P

Pay

Off

80 150 Exercise 70 20 50

100

150 Exercise 50 20 30
120 150 Exercise 30 20 10
140 150 Exercise 10 20 -10
150 150 Lapse 0 20 -20
160 150 Lapse 0 20 -20
180 150 Lapse 0 20 -20
200 150 Lapse 0 20 -20

*CMP (Current Market Price), EP (Exercise Price), IV (Intrinsic Value), P (premium)

Payoff table of Put option writer (assumed premium as \$5)
CMP EP Action IV P

Pay

Off

20 40 Exercise 0 5 5
30 40 Exercise 0 5 5
40 40 Lapse 0 5 5
50 40 Lapse 10 5 -10
60 40 Lapse 20 5 -15
70 40 Lapse 30 5 -25

* Payoff = Premium - Intrinsic Value

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