Question 21.3: You are short a put option on Oracle stock with an exercise ...
You are short a put option on Oracle stock with an exercise price of $20 that expires today. Plot the value of this option as a function of the stock price.
PLAN
Again, the strike price is $20 and in this case your cash flows will be opposite of those from Eq. 21.2, as depicted in the previous example. Thus, your cash flows will be
Put Value = Strike Price – Stock Price, if Stock Price < Strike Price
= 0, if Stock Price ≥ Strike Price (21.2)
– (20 – Stock Price) = -20 + Stock Price, if Stock Price < 20
= 0, if Stock Price ≥ 20
EXECUTE
The graph plots your cash flows:
EVALUATE
If the current stock price is $30, the put will not be exercised and you will owe nothing. If the current stock price is $15, the put will be exercised and you will lose $5. Comparing the graph here and in Example 21.2, we see that the payoffs are mirror images of each other.