Question

QUESTION 44

1. Joaquin Romero, CFA, gathered financial information concerning the common stock of Carter Company and a put option on the same stock. The market value of Carter Company stock is currently at $47.50, while a put option on a Carter Company stock is selling at $10 with an exercise price of $55.00. After doing so, he decides to implement a protective put strategy for 1,000 stocks. If the spot price of a Carter Company stock on the date of expiration of the put option is $46, what is the total gain or loss of Romero’s strategy?

	a.	$2,500 loss
	b.	$1,500 loss
	c.	$1,000 loss

Answer 1

First we need to understand a put option. The buyer of a put option has the right to sell the stock at the exercise price even when the spot price in the market is lower than that. In fact if the spot price is higher than the exercise price, then the option holder doesn't exercise the option at all.

With this understanding, we can calculate the profit or loss with the information given to us:

Premium per option	$10
No. of stock	1000
No. of put options	1000
Exercise price	55
Spot Price	46
Total premium paid	10 x 1000 = 10000
Total payoff	(55-46) x 1000=9000
Profit= Total payoff-Total Premium	9000-10000=-1000

We assume that each put option has 1 stock as its underlying. Therefore this leads to a loss of $1000