
Explanation:
Payoff to the long position =
= \max(0, \`30 - \
Payoff the short position, payoff =
Profit to the short position =
where is the option premium
Profit = \`0.50 - 0 = \
Detailed Response
In option contracts, there are always two parties:
(I) the buyer, who takes the long position, and
(II) the seller (writer) who takes the short position
It follows that the seller (short position) of a put option is the trader that promises to buy the underlying stocks at the expiry of the contract. The buyer (long position) is the party that has a right but not the obligation to sell the stocks at expiry. The buyer is also called the holder.
Holder:
At expiration, the holder will only benefit if the prevailing market price is less than the exercise/strike price. The payoff is equal to , i.e., strike price minus the market price. If the stock stays at or above, the payoff will be zero.
Q.731 Franklin Cole, an investment manager at Small Lounge Investments Co., has conducted a fundamental research on the shares of Red Hat Corp and instructed his assistant to sell put options on the shares with a strike of $30. The assistant receives a premium of $0.50. If the price of the stock increases from $30 to $33, determine the position's payoff and profit.
A
payoff = $0; profit = $0.50
B
payoff = $0.5; profit = $0.50
C
payoff = $0; profit = $0
D
payoff = $3; profit = $0.50
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