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Put options

You just bought 100 December 2007 put options selling at \$5 of stock. The option has a strike price of \$24.50 and the stock is selling at \$20.50 per share. You want to make money and have no stock currently.

a.How much of the \$5 option price is a premium?
b. How much did you pay for your investment in the 100 option contracts?
c. How many shares of stock do you control?
d.Assume that it is the last trading day in December before the option is set to expire. The stock price is at \$23. Assume the option is selling for its exercise value. How much have you earned on your investment (total \$) and what should you do?
e.Now assume that it is the last trading day in December before the option is set to expire, and the stock price is at \$31. Assume the option is selling for its exercise value. How much have you earned on your investment and what should you do?

Solution Preview

You just bought 100 December 2007 put options selling at \$5 of stock. The option has a strike price of \$24.50 and the stock is selling at \$20.50 per share. You want to make money and have no stock currently.

a. How much of the \$5 option price is a premium?

Option price = Intrinsic value + Speculative premium
Intrinsic value = Maximum of (Strike Price- Stock Price, 0)
= Maximum of (\$24.50- \$20.50, 0)
= Maximum of (\$4, ...