Compute the profit on the stock

Determine your uncle’s protective put profits.

a. Identify the near-term put with an exercise price closest to, but not below, the current stock price. Determine the investment required to protect all 10,000 shares. For the sake of simplicity, perform all subsequent calculations on a per share basis (i.e., calculate protective put profits for a single share rather than calculating profits using all 10,000 shares).

b. Determine the put option payoff at expiration for each stock price at $5 increments from $50 to $110 using Equation 13.2. (You can use a different range of prices if the current price of Walmart stock falls far from the centre of the $50 to $110 range. For example, use the $30 to $90 range if Walmart’s share price is about $60.)

c. Compute the profit (or loss) on the put for each stock price used in part (b). You can use Example 13.4 as a blue print for these calculations.

d. Compute the profit on the stock from the current price for each stock price used in part (b). For example, if the price of Wal-Mart stock is $80 today and then it increased to $85, your uncle would earn $5 profit per share. If the future price is $70 on the other hand, your uncle would lose $10.

e. Compute his overall profit (or loss) of the protective put (on a per share basis); that is, combine the profits from the put and the stock for each price used in parts (c) and (d).

f. Draw a profit diagram for the protective put. Your graph should have the same shape as the protective put payoff shown in Figure 13.4 Panel (a), but your diagram is shifted down by the amount of the option’s premium and the stock price.

Solution:

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