Question

Suppose you believe that Delva Corporation's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $85 per share. If you bought this option for $510.25 and Delva's stock price actually dropped to $60, what would your pre-tax net profit be?
Answer
A. -$510.25
B. $1,989.75
C. $2,089.24
D. $2,193.70
E. $2,303.38

Answer 1

Answer:

B. $1,989.75

Explanation:

Cost of option (C) = $510.25

Option selling price (Po) = $85 per share

Share price when selling (Ps) = $60 per share

Number of shares (n) = 100 shares

Since the option allows you to sell shares that are valued at $60 for at $85 each, by selling 100 shares, your total earnings are:

$E=(P_o-P_s)*n\\E=(\ 85-\ 60*)100\\E=\ 2,500$

To find the pre-tax net profit (P), subtract the amount paid for the options from your earnings:

$P=E-C= \ 2,500-\ 510.25\\P=\ 1,989.75$