Question

The recent price per share of Company X is $50 per share. Verna buys 100 shares at $50. To protect against a fall in price, Verna buys 100 put, covering 100 shares of Company X, with a strike price of $40. The put premium is $1 per share. If Company X closes at $45 per share at the expiration of the put, and Verna sells her shares at $45. What would be Verna's total profit and loss from investing in the stock and investing in the option

Answer 1

Solution) Buying price of shares = $50

Total cost of shares = 100*50 = $5000

Selling price of shares = $45 per share

Total amount by selling the shares = 45*100 = $4500

Loss on sale of shares = -5000 + 4500 = -$500

Hence, Verna will have a loss of $500 from the sale of shares

Premium paid for put option = $1 per share

Total premium paid = 1*100 = $100

Strike price of put option = $40

Since the share price at expiry is $45 which is greater than the strike price, thus, Verna will not exercise the put option. Thus, there will no cash flows from put option.

Loss on Put options = Premium paid = -$100

Total loss for Verna = Loss on sale of shares + Loss on Put options

= -$500 -$100

= -$600

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