Question

Stock XYZ is selling for $40 a share. An American put option on this stock with a strike price of $48 is trading at $10 per share. Which of the following statements is CORRECT?

a.the put is priced below its intrinsic value
b.the put is in the money
c.the put is out of the money
d.you can make arbitrage profit by buying the put and exercising it immediately

Answer 1

The American put option on stock XYZ is in the money because its strike price is higher than the stock's current trading price. The intrinsic value of the option is $8, but it is trading at $10. Therefore, immediate exercise for arbitrage is not profitable as the option's cost exceeds its intrinsic value.

Step-by-step explanation:

The correct statement about the American put option on stock XYZ with a strike price of $48 is that the put is in the money. This means that the current price of the stock ($40) is lower than the strike price of the put option ($48). Therefore, the option has intrinsic value, which is the difference between the strike price and the stock price, amounting to $8 ($48 - $40). The put option is trading at $10, which is $2 above its intrinsic value, accounting for time value and other factors. Exercising the put option immediately for arbitrage profit would not be viable since the cost of the put ($10) is higher than the intrinsic value ($8).