5. You buy the stock at a price of $43 and at the same time you buy a put option

ID: 2619519 • Letter: 5

Question

5. You buy the stock at a price of $43 and at the same time you buy a put option with an exercise price of $40, paying a premium of $ 2.

A. What is your total cost at the beginning for buying both the stock and the put option? Consider this as your total wealth.

B. If the stock price falls to $30 and you exercise the put, what would be your final wealth in this example?

C. What is your maximum total loss in dollars if the stock price falls to $10 in the market?

D. What is your maximum total loss if the stock price goes down to zero?

Part A.) we bought the stock and paid the premium on the put option.

So, Total Cost = Stock Price + Premium on the put option = 43 + 2 = $45

Part B.) If stock Price falls to $30, we exercise the put option.

Exercise Price = $40,

Value of option = 40 - 30 = $10

Final Wealth = Current Stock Price + Value of option = 30 + 10 = $40

Part C.) If stock Price Falls to $10.

Value of Option = 40 - 10 = $30

Loss on stock = 43 - 10 = $33

Total Loss = Loss on stock - Gains from put option + Premium Paid = 33 - 30 + 2 = $5

Part D.) If stock Price Falls to $0.

Value of Option = 40 - 0 = $40

Loss on stock = 43 - 0 = $43

Total Loss = Loss on stock - Gains from put option + Premium Paid = 43 - 40 + 2 = $5

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