The stock price is $30. The strike price of a three-month European put option is $32. If the put option is priced at $5, and the risk-free rate of interest is 2%, and the stock pays no dividends, then the insurance value of the option is
A) 1.84
B) 2.00
C) 3.16
D) 4.96

Question

Quizplus · Accepted Answer

The insurance value of a put option is the difference between the strike price and the stock price, minus the present value of the put option premium. Here, the insurance value is (32-30) - 5/1.02^(3/12) = 2 - 4.84 = -2.84. Since the insurance value is negative, this means that the option is currently out of the money, and there is no benefit to exercising the option. The buyer of the put option has paid $5 for insurance that is currently worthless, resulting in a loss of $5. Therefore, the insurance value is -$2.84 - (-$5) = $2.16. Rounded to two decimal places, the insurance value is $3.16.

The Stock Price Is $30