Question

If a pension fund is looking at a certain European put option with four months to expiration on a non-dividend paying stock. If the current stock price is $19.29 with a strike price of $21.25 and the risk-free interest rate is 1.75% per annum, what is a lower bound for the price of this option?

Answer 1

Current stock price(S0) = $19.29

Exercise price(X) = $21.25

Risk free rate(r) = 1.75% p.a

Maturity(t) = 4 month

We can compute the lower bound of Put option(PL) wih following equation:

$P_L = \frac{X}{e^{rt}}-S_0$

21.25 20.0175*4/12 – 19.29

P= 21.1264025098251 – 19.29

PL = 1.8364025098251

P = $1.84

Hope it will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.