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Current time:0:00Total duration:3:24

Video transcript

we have company ABCD trading at $50 a share let's draw a payoff diagram for a put option with a $50 strike price trading at $10 so once again we're going to draw two types of payoff diagrams one type that only cares about the value of the option at expiration and this is what you tend to see in academic settings business schools or textbooks and then the other one will actually draw the profit and loss up based on that option position and so it incorporates the price you actually paid for the option you tend to see this more in practice so you have a put option remember this is the right to sell this is the right to sell the stock at $50 so if the stock let's say at expiration so all of this is at expiration if at expiration the stock is trading at zero the company went bankrupt it's now worthless what is the put option worth well you would now go on to the market buy it for pennies or buy it for almost zero dollars and then you would exercise your put option and you would sell it for $50 so you would definitely exercise and you would make a lot of money if the underlying stock can be bought for zero the put option is now worth $50 because you can buy it for zero and then sell it for $50 if you have the put option if the underlying stock price is if the underlying stock price is ten dollars then you still could go buy the stock for ten dollars if you have the option you would exercise the option to sell it at 50 so you would make $40 so the option would be worth $40 anyone who is holding the option would make an instant $40 so it goes the value of the option becomes less and less as the value of the stock becomes more and more up until you get to $50 at $50 you wouldn't really care you could you have the right to sell something at $50 which you could buy for $50 so it's kind of worth noting so the value of the put option it starts at $50 because you have the right to sell something that's worthless at $50 if the stock were to go bankrupt then and then at $50 it becomes the the option you don't really has it doesn't have any value any more and if the stock goes anything above $50 it still is worthless if the stock is if the stock is at $100 something like that there's no way you would exercise the option because why would you why would you exercise the right to sell something at 50 we're on the open market you could sell it at 100 now let's do the same thing for the profit and loss version so if the stock is worth nothing you could buy it for nothing and then if you have the option sell it for $50 but we have to incorporate the fact that you paid $10 for the option so instead of saying that the option is worth 50 we would say it's worth 50 minus this 10 so it would be worth $40 and this is all the way you would exercise the option all the way until you the option is worth $50 but at $50 instead of saying it's worthless you have to remember at 50 if the stock is $50 you wouldn't exercise the option but you did pay $10 for it so you wouldn't exercise something that you paid $10 for so you would have to take a $10 loss so the option starts at 50 and becomes worth less less less and less all the way to the point that if you don't exercise it you took the loss of paying for an option and not exercising it and then any stock price above that you just took you just took a $10 loss