Question

Suppose you bought a derivative asset that gives you the right to sell Asset ABC for $16.75 prior to or on April 20, 2018. The current price of the stock is $16.92. The cost of the derivative asset is quoted as $.31. Given that you bought one contract, what is the maximum possible loss on the trade?

a. $1,644

b. $31

c. $1,706

d. $48

Show your work.

Answer 1

There are 2 type of options:

Call option

here call option buyer buys the right to buy and seller has the obligation to sell

Put option

here put option buyer buys the right to sell and put option seller has the obligation to buy

In the above case there is put option as the right to sell is bought and for that premium is to be paid by buyer of option to seller of optionwhich is given $31

while buying the option for right to sell put option buyer has paid premium of $31

current stock price = 16.92

while put option buyer has the option to sell at $16.75

which is lower than current market price hence put option buyer will not exercise the option that is he will not sell at $ 16.75

Hence his loss will beto the extent premium paid i.e $31

Hence option B is correct