The maximum amount that a writer of a put option on a stock may need to pay at the option expiry is _________.

Question

The maximum amount that a writer of a put option on a stock may need to pay at the option expiry is  _________.

BlackTom AI · Accepted Answer

First, let's restate the problem to set the stage: The question asks for the maximum amount a writer of a put option on a stock may need to pay at option expiry, and it provides four options to choose from.
Option 1: 'unlimited' — This is not correct. A put writer’s potential obligation is not unlimited because the stock price cannot drive a loss beyond the strike price; the payout is capped when the stock goes to zero, and the writer would simply have to deliver the stock or cash settlement up to the exercise price, not infinite money.
Option 2: 'equal to the exercise price' — This aligns with the fundamental payoff of a put option for the writer. If the stock price falls to zero, the put is exercised, and the writer must buy the stock at the strike price (or settle equivalently), incurring a loss of up to the strike price minus any premium received. Therefore, the maximum monetary obligation at expiry is the exercise price itself.
Option 3: 'equal to the underlying stock price' — This is incorrect. The writer’s liability is not tied to the current stock price at expiry directly; it is determined by how far the stock price is below the strike, i.e., the intrinsic value, capped by the strike price. It cannot exceed the exercise price, and certainly is not simply the stock price alone.
Option 4: 'equal to the put premium' — This underestimates the risk, since the premium is the income the writer receives up front and is not the amount they could owe at expiry. The premium represents the income component, not the potential outlay; the worst case is when the option is deep in the money, which corresponds to the exercise value up to the strike price.
In summary, option 2 correctly identifies the ceiling of potential liability for a put writer at expiry as the exercise price, while the other options misstate the nature of the writer’s maximum exposure or confuse premium income with potential payables.

FINANCE 261 Quiz 5

The maximum amount that a writer of a put option on a stock may need to pay at the option expiry is _________.

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