CFA CFA Level 1 Question of the Week – Derivatives

# Question of the Week – Derivatives

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Participant
• Undecided
1

Jonathan sells Stephen a 4-month put option on Sign Partners for \$5. Sign Partners is trading for \$50, and the strike price is \$48. Assuming stock prices continue trending upwards as they have in the past, who is most likely to make a profit?

• Stephen
• Jonathan
• Not enough information
Participant
• Undecided
5

The break-even point for this option is \$43, meaning
that the stock must drop from \$50 to \$43 within the next four months. It is
entirely possible that such a situation could
happen (which is why the put is worth \$5), but chances are that it won’t happen. In that case, Jonathan is most likely to make a
profit.

Note that while it is less
likely for Stephen to make a profit, he does have greater profit potential,
which is why he would purchase this option in the first place.

• shannondaily
Participant
• Undecided
3

Woo! I got it right.

• LeChiffre
Participant
• CFA Level 2
1

Look at this from Stephen’s perspective. He purchased the right to sell (strike) Sign Partners at \$48 per share. He may not sell at a price > \$48. The stock is currently trading at \$50 and is trending upward. Stephen will not be able to exercise the option. He has already paid Jon \$5, so it is most likely that Jon will not have to purchase the stock from Stephen and Jon will pocket the \$5, making a profit.