Ed martin, the pension fund manager for Strak Corporation, is considering purcha

Question

Ed martin, the pension fund manager for Strak Corporation, is considering purchase of a put option in anticipation of a price decline in the stock of Carlisle, Inc. The option to sell 100 shares of Carlisle, Inc at any time during the next 90 days at a strike price of $45 can be purchased for $380. The stock of Carlisle is currently selling for $46 per share.

a. Ignoring any brokerage fees or dividends, what profit or loss will Ed make if he buys the option and the lowest price of Carlisle stock dring the 90 days is $46, $44, $40 and $34?

b. What effect would the fact that the price of Carlisle's stock slowly rose from its initial $46 level to $55 at the end of 90 days have on Ed's purchase?

c. In light of your findings, discuss the potential risks and returns from using put otions to attempt to profit from an anticipated decline in share price?

**Show work please***

Explanation / Answer

a)

Carlisles trading at $46, its $45 put is trading at $3.80.
Long Put Profit = (strike - stock) - premium

$46: $45put are out of the money and loses the whole $3.80

$44: (45 - 44) - 3.80 = 1 - 3.80 = -2.80

Total=-2.80*100=-$280 LOSS

$40: (45 - 40) - 3.80 = 5 - 3.80 = 1.20

Total=1.20*100= $120 PROFIT

$35: (45 - 35) - 3.80 = 10 - 3.80 = $6.20

Total=100*6.2= $620 PROFIT

b)

$45put gets more and more out of the money and becomes cheaper and cheaper and eventually expires worthless.

c)

Option should not be exercised.

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