Question

Suppose that you own an American put option on a non-dividend paying stock with a strike price of $50 that will expire in six months. The current stock price is $1, and the six-month risk- free rate of interest is 5% with continuous compounding

(a) If you exercise the put today and invest the proceeds, how much will you have in six-months?

(b) What is the maximum payoff you can obtain if you keep the option until expiration? Explain.

Answer 1

if you exercu=ised the put option today

Inflow of funds is = exercise price -current market price -put option premium

= 50-1-0

= 49$

Since data relating to premium is not given it is assumed as Zero

Invest 49$ at a interest rate of 5%

Funds after 6 months = 49(1+(6/100)*6/12) 6 percent for 1 year for 6 months 6%*6/12

=50.47

B. The Maximum Payoff i can get is =Exercise price -Current market price -Put premium

=50-Current market price -Put premium

In the worst senario if stock price become zero

The maximum pay off ican get is = 50-0-0

=50

Since put premium not given assumed as zero