Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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### Understanding Put Options in Finance

A put option in finance allows you to sell a share of stock at a given price in the future. There are different types of put options. A European put option allows you to sell a share of stock at a given price, known as the exercise price, at a specific point in time after purchasing the option. 

#### Example Scenario:
- Suppose you buy a six-month European put option for a stock with an exercise price of $26.
- If after six months the stock price per share is $26 or more, the option has no value.
- If the stock price is lower than $26, you can purchase the stock and sell it at $26 using the put option.

#### Profit Calculation:
- If the price per share in six months is $22.50, you buy the stock at $22.50 and sell it immediately for $26 using the option.
- Profit: $26 - $22.50 = $3.50 per share, minus the cost of the option.
- If you paid $1.00 per option, profit = $3.50 - $1.00 = $2.50 per share.

#### Risk Management:
- Purchasing a European put option limits the risk of a decrease in the stock’s per-share price.
- Example: You purchased 200 shares at $28 each and 85 six-month put options with an exercise price of $26, each costing $1.

#### Data Table Analysis:
(a) Construct a model using data tables to show the portfolio value with and without options for six-month six-month future share prices between $20 and $29 in $1 increments.

- **Share Price vs. Benefit of Options:**
  - $20: $350
  - $21: $280
  - $22: $210
  - $23: $140
  - $24: $70
  - $25: $0
  - $26: -$70
  - $27: -$70
  - $28: -$70

Negative numbers indicate a loss, and zero indicates no gain or loss. The analysis helps in strategizing the implementation of put options to mitigate risks effectively.
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Transcribed Image Text:### Understanding Put Options in Finance A put option in finance allows you to sell a share of stock at a given price in the future. There are different types of put options. A European put option allows you to sell a share of stock at a given price, known as the exercise price, at a specific point in time after purchasing the option. #### Example Scenario: - Suppose you buy a six-month European put option for a stock with an exercise price of $26. - If after six months the stock price per share is $26 or more, the option has no value. - If the stock price is lower than $26, you can purchase the stock and sell it at $26 using the put option. #### Profit Calculation: - If the price per share in six months is $22.50, you buy the stock at $22.50 and sell it immediately for $26 using the option. - Profit: $26 - $22.50 = $3.50 per share, minus the cost of the option. - If you paid $1.00 per option, profit = $3.50 - $1.00 = $2.50 per share. #### Risk Management: - Purchasing a European put option limits the risk of a decrease in the stock’s per-share price. - Example: You purchased 200 shares at $28 each and 85 six-month put options with an exercise price of $26, each costing $1. #### Data Table Analysis: (a) Construct a model using data tables to show the portfolio value with and without options for six-month six-month future share prices between $20 and $29 in $1 increments. - **Share Price vs. Benefit of Options:** - $20: $350 - $21: $280 - $22: $210 - $23: $140 - $24: $70 - $25: $0 - $26: -$70 - $27: -$70 - $28: -$70 Negative numbers indicate a loss, and zero indicates no gain or loss. The analysis helps in strategizing the implementation of put options to mitigate risks effectively.
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