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Johnstone Co. purchased a put option on Ewing ordinary shares on July 7, 2010, for $240. The

Question:

Johnstone Co. purchased a put option on Ewing ordinary shares on July 7, 2010, for $240. The put option is for 200 shares, and the strike price is $70. (The market price of an ordinary share of Ewing on that date is $70.) The option expires on January 31, 2011. The following data are available with respect to the put option.


Johnstone Co. purchased a put option on Ewing ordinary shares


Instructions
Prepare the journal entries for Johnstone Co. for the following dates.
(a) July 7, 2010—Investment in put option on Ewing shares.
(b) September 30, 2010—Johnstone prepares financial statements.
(c) December 31, 2010—Johnstone prepares financial statements.
(d) January 31, 2011—Put optionexpires.

Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity.
Transcribed Image Text:

Market Price of Ewing Shares $77 per share 75 per share 78 per share Date Time Value of Put Option September 30, 2010 December 31, 2010 January 31, 2011 $125 50 0

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a July 7 2010 Put Option 240 Cash 240 b September 30 2010 U...View the full answer


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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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