So = $40, St = $43
American put long: Po = 2.75, X = 38
American put short: Po = 3.75, X = 42
The instrinc value of a call is Max [0 , S-X] = Max [0, 43-42] =$1
My question is how do we know which strike price to use?
These two options are different here. They have different strike prices. It’s $38 for the first option, and $42 for the second one.
The intrinsic value of a put option = max (0, X-S). If St is the current price of the underlying asset, then both options have an intrinsic value = 0.
For the first option: intrinsic value = max (0,38-43) = 0
For the second option: intrinsic value = max (0,42-43) = 0
It is asking for the intrinsic value of a call, not a put although the info given are about put options
The answer given was Max [0, 43-42] = 1
That’s why I’m confused.
Well, in this case I have no idea. I don’t see why we could not use the other one…
I might be wrong but the long call and short put both want a price increase to be beneficial to the holder of that position, so because they are most similar they use the short put strike price and not the long put to determine the intrinsic value of holding a long call.
Thanks Chippychips, that makes sense!
No prob, all the best