Question 21.2: You own a put option on Oracle stock with an exercise price ...

PLAN
From Eq. 21.2, and the fact that the strike price is $20, we see that the value of the put option is:

Put Value = Strike Price – Stock Price, if Stock Price < Strike Price
= 0,         if Stock Price ≤ Strike Price       (21.2)
Put Value = 20 – Stock Price, if Stock Price < 20; = 0, if Stock Price ≥ 20

EXECUTE
Plotting this function gives:

EVALUATE
Because the put option allows you to force the put writer to buy the stock for $20, regardless of the current market price, we can see that the put option payoff increases as Oracle’s stock price decreases. For example, if Oracle’s price were $10, you could buy a share of Oracle in the market for $10 and then sell it to the put writer for $20, making a profit of $10.