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(a) Vince longs a put option on Junebank's stock with a strike price at RM13
(a) Vince longs a put option on Junebank's stock with a strike price at RM13. Currently Junebank's stock is priced at RM15 and the option premium is RM1.50. (i) Advise Vince whether or not to exercise the option. Justify your answer. (2 marks) (ii) Draw an expiry profit diagram for the Junebank's position. (6 marks) (iii) Explain the profit and loss for Vince and Junebank. (2 marks) (iv) What would be the profit and loss for both parties if the stock price decreases to RM11? (4 marks)
Expert Solution
Put option gives right to its buyer to sell underlying at specified price in future. Thus put option will be exercised if price as at expiry is less than the strike price. Hence for seller of put it becomes obligation to buy underlying when buyer enforceses his right. To Buy put option one has to pay premium and hence seller receives the premium
i) Here strike price = RM 13
Stock price = RM 15
Since stock price is more than strike price , put option should not be exercied
ii) Here June bank is seller of the put option and it will receive premium of RM 1.5
Table showing profit or loss
| Price as at expiry | Loss on put option sold | Premium received | Net profit/Loss |
| A | BV | A+B | |
| 8 | -5 | 1.5 | -3.5 |
| 9 | -4 | 1.5 | -2.5 |
| 10 | -3 | 1.5 | -1.5 |
| 11 | -2 | 1.5 | -0.5 |
| 12 | -1 | 1.5 | 0.5 |
| 13 | 0 | 1.5 | 1.5 |
| 14 | 0 | 1.5 | 1.5 |
| 15 | 0 | 1.5 | 1.5 |
| 16 | 0 | 1.5 | 1.5 |
| 17 | 0 | 1.5 | 1.5 |
| 18 | 0 | 1.5 | 1.5 |
| 19 | 0 | 1.5 | 1.5 |
| 20 | 0 | 1.5 | 1.5 |
| 21 | 0 | 1.5 | 1.5 |
| 22 | 0 | 1.5 | 1.5 |
| 23 | 0 | 1.5 | 1.5 |
| 24 | 0 | 1.5 | 1.5 |
| 25 | 0 | 1.5 | 1.5 |
Profit diagram
iii) Break even point = Strike price - premium paid = 13 - 1.5 = 11.5 RM
Vince will profit is stock price moves down below RM 11.5 . where as June bane will profit if stock stays above RM 11.5
iv) If stock price decrease to 11 RM
Profit to Vince = profit on exercise of put option - Premium paid
= (13 - 11) - 1.5
= 2 - 1.5
= 0.5 RM
Since stock price have moved below 11.5 RM ,June bank will have to face loss.
Loss = Loss on exercise of put option + Premium received
= (11 - 13) + 1.5
= -2 + 1.5
= - 0.5 RM
please see the attached file for the complete solution.
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