You have purchased a put option on Kimberly Clark common stock. The option has an exercise price of $67 and Kimberly Clark's stock currently trades at $68.18. The option premium is $1.34 per contract. One option equals 100 shares of the underlying stock. a. Calculate your net profit on the option if Kimberly Clark's stock price falls to $65 and you exercise the option. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations.) b. Calculate your net profit on the option if Kimberly Clark's stock price does not change over the life of the option. (Negative amount should be indicated by a minus sign.)

Question

Shayla

Business

8 August, 16:35

You have purchased a put option on Kimberly Clark common stock. The option has an exercise price of $67 and Kimberly Clark's stock currently trades at $68.18. The option premium is $1.34 per contract. One option equals 100 shares of the underlying stock. a. Calculate your net profit on the option if Kimberly Clark's stock price falls to $65 and you exercise the option. (Negative amount should be indicated by a minus sign. Do not round intermediate calculations.) b. Calculate your net profit on the option if Kimberly Clark's stock price does not change over the life of the option. (Negative amount should be indicated by a minus sign.)

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Jocelynn Ball · Answer 1

a. $66

b. Total loss $134

Explanation:

Let's start from the very basic.

A put option is an option contract giving the buyer of the option, the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time.

Here we are the buyer of put option. So, we will only exercise the option, if we are in the money.

To check if we are in the money we can just check the following equality.

In-the-Money (Put) = Strike Price > Underlying Price + Option premium

Our strike price is $67 and the underlying price is $65 and the option premium is $1.34

To get the value of an in the money put we can simply use the following formula.

Value = (Strike Price * No of shares) - (Underlying price * no of shares) - (Option premium * Number of shares)

Value = $6,700 - $6,500 - $134

= $66

Again to check if we are in the money we use the old formula

In-the-Money (Put) = Strike Price > Underlying Price + Option premium

The stock price here does not change over the life of contract hence our strike price is lower than the underlying price. So, in this case we are not in the money, and we are instead out of the money.

So, we are just going to let our option expire, without exercising it. But, we still paid the option premium in the beginning of the period, while buying the contract. So, the total amount of loss incurred on the option contract would be the option premium into the number of shares.

Total loss = $1.34 * 100 = $134