Question

In March, a U.S. investor instructs a broker to sell one July put option contract on a stock. The stock price is $42 and the strike price is $40. The option price is $3. Explain what the investor has agreed to. Under what circumstances will the trade prove to be profitable? What are the risks?

Answer 1

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solution us investor instructs the broker to sell July put option In Ich march o the stock/spot price = $42 option price = $3. Strike price = $40 * The investor has agreed to buy the stocks at a price of $40 in Truly, if the stock prices falls below $40. - The trade will be profitable to the investor if Payoff of short put option optice price - maxlo, Strike price-spotpriul & 3-Max (0, 40-5)

Breakeven point 3-40+ so 8 = 37 So, the trade will prove to be profitable as long as the underlying stock price doest fall below $37. This is the breakeven point at which a $3 loss on the stock purchase equals the $3 premium collected 3 The risk associated with this trade & that the underlying stock price, currently $42, could fall to zers under adverse circumstances. This expose the Pnvestor to a potential loss of $37, which reflects a $40 loss on the stock Purchase ro_40) pulus the $3 premiina collected.