A European option giving the right to sell a stock at $100 sells for $5. Under what circumstance will the buyer of the option make a profit? Select one: a. When the stock price at maturity is less than $95 b. When the stock price at maturity is less than $100 c. When the stock price anytime up to maturity is less than $95 d. When the stock price at maturity is greater than $100
Question
A European option giving the right to sell a stock at 5. Under what circumstance will the buyer of the option make a profit?
Select one:
a. When the stock price at maturity is less than $95
b. When the stock price at maturity is less than $100
c. When the stock price anytime up to maturity is less than $95
d. When the stock price at maturity is greater than $100
Solution
The correct answer is:
a. When the stock price at maturity is less than $95
Here's why:
The buyer of the option has the right to sell the stock at 5 for this right. Therefore, they will only start to make a profit when they can sell the stock for more than they paid for it, which is 5 = $105.
However, since they are selling the stock (not buying it), they make a profit when the stock price is less than 100, so they make a profit when the stock price at maturity is less than 5 = $95.
So, the buyer of the option will make a profit when the stock price at maturity is less than $95.
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