Understanding the Payoffs for Options on Verdant, Inc. Stock

A

Let's break down the information given in the question:

• Call options on the stock of Verdant, Inc. have a strike price of $45 and are priced at $3.75.
• Put options on the stock of Verdant, Inc. also have a strike price of $45 and are priced at $3.00.

To understand the potential payoffs for owners of these options, we need to consider the concepts of call options and put options.

1. Call options: A call option gives the owner the right, but not the obligation, to buy the underlying asset (in this case, the stock of Verdant, Inc.) at the strike price ($45) on or before the expiration date.

• The call option is priced at $3.75, which is also known as the premium.
• If the stock price of Verdant, Inc. is above the strike price ($45) at expiration, the call option is in-the-money, and the owner can exercise the option to buy the stock at the strike price and then sell it at the higher market price. This results in a profit equal to the stock price minus the strike price, minus the premium paid.
• If the stock price is at or below the strike price at expiration, the call option is out-of-the-money, and it would not be beneficial for the owner to exercise the option. In this case, the maximum loss for the call option owner is the premium paid ($3.75).

2. Put options: A put option gives the owner the right, but not the obligation, to sell the underlying asset (the stock of Verdant, Inc.) at the strike price ($45) on or before the expiration date.

• The put option is priced at $3.00, which is also known as the premium.
• If the stock price of Verdant, Inc. is below the strike price ($45) at expiration, the put option is in-the-money, and the owner can exercise the option to sell the stock at the strike price, which is higher than the market price. This results in a profit equal to the strike price minus the stock price, minus the premium paid.
• If the stock price is at or above the strike price at expiration, the put option is out-of-the-money, and it would not be beneficial for the owner to exercise the option. In this case, the maximum loss for the put option owner is the premium paid ($3.00).

Now, let's evaluate the answer choices based on the above explanations:

A. The call writer has the maximum loss exposure.

• This statement is incorrect because the call writer (also known as the call option seller) receives the premium from selling the call option and has the obligation to sell the stock if the option is exercised. The maximum loss for the call writer is not defined solely by the premium received.

B. The put buyer has the maximum loss exposure.

• This statement is correct. The put buyer (the owner of the put option) pays the premium and has the right to sell the stock at the strike price. If the stock price remains above the strike price at expiration, the put option will be out-of-the-money, and the maximum loss for the put buyer will be the premium paid.

C. The put writer has the maximum potential gain.

• This statement is incorrect. The put writer (also known as the put option seller) receives the premium from selling the put option but has the obligation to buy the stock if the option is exercised. The potential gain for the put writer is limited to the premium received and not necessarily the maximum potential gain among the given options.

Therefore, the correct answer is B. The put buyer has the maximum loss exposure.