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April 2006 - Q9(vi)(b)

K

kathrynT

Member
I've got a query with the above question if anyone can help.

The solutions to this question say that for the put option - the profit if held if the price goes down is either

101-97 = 4 (if up movement)
or
101-94.502 = 6.498 (if down movement)

which all makes sense.

My question is

why doesn't the profit include the 3p dividend as the holder of a put option would receive the dividend. Or do we assume that the holder of a put option doesn't actually own the share? Maybe I'm missing something!

I know it's a technicality as all this would do is increase the profit at t=2 so make the case for not exercising stronger. Just wondering really!

Thanks

Kathryn
 
I think we assume that the investor doesn't actually hold a share.

In general there's no reason to assume that the holder of a put option also has a share he wants to get rid of. He'll still make a profit if S is below K at expiry, by buying one share for price S and exercising the put at the same time.

Hope this helps.
 
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