# Fundamentals of Futures and Options Markets 7e

33967 Words Oct 30th, 2012 136 Pages
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CHAPTER 1 Introduction
Practice Questions
Problem 1.8. Suppose you own 5,000 shares that are worth \$25 each. How can put options be used to provide you with insurance against a decline in the value of your holding over the next four months? You should buy 50 put option contracts (each on 100 shares) with a strike price of \$25 and an expiration date in four months. If at the end of four months the stock price proves to be less than \$25, you can exercise the options and sell the shares for \$25 each.

Problem 1.9. A stock when it is first issued provides funds for a company. Is the same true of an exchangetraded stock option? Discuss. An exchange-traded stock option provides no funds for the company. It is a
The profit as a function of the stock price is shown in Figure S1.1.

Figure S1.1

Profit from long position in Problem 1.13

Problem 1.14. Suppose that a June put option on a stock with a strike price of \$60 costs \$4 and is held until June. Under what circumstances will the holder of the option make a gain? Under what circumstances will the option be exercised? Draw a diagram showing how the profit on a short position in the option depends on the stock price at the maturity of the option.

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The seller of the option will lose if the price of the stock is below \$56.00 in June. (This ignores the time value of money.) The option will be exercised if the price of the stock is below \$60.00 in June. The profit as a function of the stock price is shown in Figure S1.2.

Figure S1.2

Profit from short position In Problem 1.1

Problem 1.15. It is May and a trader writes a September call option with a strike price of \$20. The stock price is \$18, and the option price is \$2. Describe the investor’s cash flows if the option is held until September and the stock price is \$25 at this time. The trader has an inflow of \$2 in May and an outflow of \$5 in September. The \$2 is the cash received from the sale of the option. The \$5 is the result of the option being exercised. The investor has to buy the stock for \$25 in September and sell it to the purchaser of the option for \$20. Problem 1.16. An investor writes a