Chapter 15, Problem 5PS

Summary Introduction

Put option:

It is an agreement that gives the buyer the right entitled to sell a stock at a pre-specified price (known as exercise price or strike price) within a pre-specified period. The stock on which the put option is provided is called the asset underlying.

Pay off from a put option:

The payoff from a put option contract for its holder is regarded as the strike price less the current price of the underlying asset. So, higher the strike price compared to the current price of the underlying asset, higher is the value of the put option. In other words, the worth of put options increases with the difference between the price of underlying asset and the strike price where the stock price of underlying asset is less than the strike price. And the worth of a put option dictates the purchase price of a put option. More worthy the put option, higher will be its purchase price.

When the strike price is less than the stock price, the exercise of put option will cause negative cash flow. So, in that case, put option is not exercised and causes zero payoff.

Profit from a put option:

The profit from a put contract for its holder is the payoff from a put option less its purchase price, paid earlier.

To compute:

The maximum possible profit from the given put option for its holder