Question

13. Reducing risks with put options Aa Aa Alison owns 100 shares of RTE Telecom Inc. stock that she bought for $40 per share. Alison bought a put option for all 100 shares of the stock with a strike price of $37 per share, option price of $2 per share, and a three-month term. Alison probably bought the option because she What did Alison pay to buy the option? $| sees a bright future for the company and its stock Under which circumstances will Alison most likely exercise her option? Check all that apply The stock price per share Drops to $34 Rises to $49 Remains the same and Alison exercises her option, calculate Alison's net completing the following table. Enter all figures as positive numbers. Proceeds from sale $ Less: Premium - Net proceeds If Alison did not have a put option and sold her stock on the open market, what would she receive? $ from having the put option by $ Including the premium cost, Alison

Answer 1

Alison bought the put options on the basis of the expectation that the stock price might decline.

Alison paid the premium amount of $2 in order to buy the put option.

Since, Alison has bought a put option at a strike price of $37, and the stock price falls to $34, Alison will exercise the option in case the stock price falls below $37. Put options are exercised when the stock price falls below the exercise price.

So, the correct option is option a.

Proceeds from sale = 100 shares * $3 ( $37 - $34)

Strike price - exercise price = $37 - $34

Proceeds from sale = $3 * 100

= $300

Premium paid for the put option = $2 * 100 = $200

SO, net proceeds = $300 - $200

= $100

If she had sold the stock in the open market without the put option she would receive = 100 shares * $34

= $3400

If she had the option, including the put option she would reduce her total loss from having the put option by $100.

As after the fall in price to $34, the put option will also be exercised by which Alison will be gaining $100.