Explanation:
The price of an American put option should be equal to or lower than the strike price of the option on the underlying stock. This is because the value of a put option is derived from the right it provides to its holder to sell the underlying asset at the strike price. If the price of the put option were to exceed the strike price, it would mean that the holder is paying more for the option than they would receive from exercising it. This would not be rational, as the holder could instead sell the asset in the market at a higher price. Therefore, the price of a put option should never exceed the strike price of the option. If it does, an arbitrage opportunity would arise. An investor could sell the overpriced put option, invest the proceeds at the risk-free rate, and make a risk-free profit. This is why the price of an American put option should be equal to or lower than the strike price of the option on the underlying stock.
Q.751 Upper and lower pricing bounds for American and European call and put options are important in order to prevent investors from earning arbitrage profits. If option prices are above the upper boundary or below the lower boundary, an investor can earn arbitrage profit by opening a position in an options contract and in the underlying stock simultaneously. Which of the following statements is consistent with the upper boundary limit of the American put option?
A
The price of an American put option should be equal to or higher than the current price of the underlying stock.
B
The price of an American put option should be equal to or higher than the strike price of the option on the underlying stock.
C
The price of the American put option should be equal to or lower than the current price of the underlying stock.
D
The price of the American put option should be equal to or lower than the strike price of the option on the underlying stock.
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