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Warren Co. purchased a put option on Echo ordinary shares on January 7, 2010, for $360. The

Question:

Warren Co. purchased a put option on Echo ordinary shares on January 7, 2010, for $360. The put option is for 400 shares, and the strike price is $85 (which equals the price of an Echo share on the purchase date). The option expires on July 31, 2010. The following data are avail-able with respect to the put option.

Warren Co. purchased a put option on Echo ordinary shares


Instructions
Prepare the journal entries for Warren Co. for the following dates.
(a) January 7, 2010—Investment in put option on Echo shares.
(b) March 31, 2010—Warren prepares financial statements.
(c) June 30, 2010—Warren prepares financial statements.
(d) July 6, 2010—Warren settles the put option on the Echoshares.

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:

Date Market Price of Echo Shares $80 per share 82 per share 77 per share Time Value of Put Option March 31, 2010 June 30, 2010 July 6, 2010 $200 90 25

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a January 7 2010 Put Option 360 Cash 360 b March 31 2010 Put Option 2000 Unrealized Hol...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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