CFA CFA Level 1 Question of the Week – Derivatives

Question of the Week – Derivatives

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    • AdaptPrep
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      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
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    • LeChiffre
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      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.

    • AdaptPrep
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      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
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      Woo! I got it right. 

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