The put option of Joe Inc. is currently trading at $2.50 while the call option premium is $7.50. Both the put and the call have an exercise price of $25. Joe Inc. stock is currently trading at $32.25 and the risk-free rate is 3%. The options will expire in one month.

1. An investor applies a protective put strategy by buying the put option of Joe Inc. to protect his holding of the company's stock. This strategy creates a portfolio of long stock and long put, which provides a payoff of unlimited upside potential with a limited loss. This is similar to buying a call option (i.e., a long call position) of Joe Inc. that also provides unlimited upside profit potential with a limited loss (the maximum loss will be the option premium paid).

Student teams are expected to investigate the profit/loss possibilities at options expiration for the protective put portfolio vs. the long call position. For example, if the stock price is $14 when options expire, stock's profit/loss will be $l4 - $32.25 = -$18.25 (i.e., a loss), long put option's profit/loss will be $25 - $14 - $2.5 = $8.5 (i.e., a profit), and long call option's profit/loss will be $0 - $7.5 = -$7.5 (i.e., a loss). Thus, a protective-put portfolio of long stock and long put will incur the portfolio's profit/loss of-$18.25 + $8.5 = -$9.75, while the long call position will suffer -$7.5 loss. These profits/losses are entered in the following table for Stock Price = 14.00. Complete the following table for different stock prices other than $14.00. In this exercise, ignore the interest costs on capital.

Calculation of Stock Option Profit/Loss (Without Considering Interest)