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.
