Calc option payoff on a put reference, different, computing, understand

andytrader

Own at Put(X=35); Stock prices 33.5 at expiration; RFR = 4%

The put option is worth the greater of $0 or (exercise price – spot price at expiration). Since the exercise price is greater than the spot price at expiration, the put is worth (35 – 33.50) = $1.50.

I understand RFR is required for computing American from European style options, but given no reference, how would you know which was asked in the question?

Is it that payoff is different from the value of the option in which case we would use RFR to compute the value?

I am beginning to lose it..

invic

I think you are correct. If I can recall correctly, payoff is different from value. But Payoff also includes option premium.

Please verify it in the text.

shootingstar

In this case, the value of the asset at expiration is already known --> put worth at expiration (35 – 33.50) = $1.50. If you want to know what is worth now, discount back with RFR.
IN this case, American or European is not different since no extra premium for having the right to exercise before expiration.

In other cases (underlying cash flow, unknown asset value at expiration,..) the conclusion is different.

amqata

for put, american is different from european style.

For american -- max (0, exercise price - spot price)

For European - max(0, exercise price /RFR - spot price)

Because for American you can exercise it immediately, so for present value you dont have to discount it.

mnieman

cfa1try
I have not seen the formula you gave earlier so I do not understand it nor your explanation.
You care some further explanation, as well as show the numbers using the example above?

thisisbrianly

ov25 Wrote:
-------------------------------------------------------
> I understand RFR is required for computing
> American from European style options, but given no
> reference, how would you know which was asked in
> the question?

I am sure there would not be ambiguity in the exams question.

> Is it that payoff is different from the value of
> the option in which case we would use RFR to
> compute the value?

Payoff is same as value. Profit is not same as value. Be clear to distinguish between payoff diagrams and profit/loss diagrams as well.