Your uncle owns 10,000 shares of Walmart stock. He is concerned about the short-term outlook for Walmart’s stock due to an impending “major announcement.” This announcement has received much attention in the press so he expects the stock price will change significantly in the next month, but is unsure whether it will be a profit or a loss. He expects the news will be good and the price will increase, but he also doesn’t want to suffer if the price were to fall in the short term.
His broker recommended he buy a “protective put” on the stock, but your uncle has never traded options before and is not much of a risk taker. He wants you to devise a plan for him to capitalize if the announcement is positive but to still be protected if the news causes the price to drop.
You realize that a protective put will protect him from the downside risk, but you think a straddle may offer similar downside protection, while increasing the upside potential. You decide to show him both strategies and the resulting profits and returns he could face from each.
1. Download option quotes on options that expire in approximately one month on Walmart into an Excel spreadsheet. Be sure to include quotes for a range of strike prices both above and below the current stock price.
2. Determine your uncle’s profit and return using the protective put.

a. Identify the expiring put with an exercise price closest to, but not below, the current stock price. Determine the investment required to protect all 10,000 shares.

b. Determine the put payoff at expiration for each stock price at \($5\) increments within a range of \($40\) of Walmart’s current price using Eq. 20.2.

c. Compute the profit (or loss) on the put for each stock price used in part (b).

d. Compute the profit (or loss) on the stock, relative to the current price, for each stock price used in part (b).

e. Compute his overall profit (or loss) of the protective put by combining the profit from the put and the stock for each price used in parts (c) and (d).

f. Compute the overall return of the protective put by comparing the total final payoff of the stock and the put to their initial value using the same range of final stock prices.
3. Determine your uncle’s profit and return using the straddle.

a. Compute the investment your uncle would have to make to purchase the call and put with the same exercise price and expiration as the put option in Question 2, to cover all 10,000 of his shares.

b. Determine the value at expiration of the call options at each \($5\) increment of stock prices within a range of \($40\) of Walmart’s current price using Eqs. 20.1 and 20.2.

c. Determine the profit (or loss) on the call options at each stock price used in part (b).

d. Compute his overall profit (or loss) of the stock plus straddle by combining the profit from the call position with that of the protective put portfolio in Question 2 (e) for each price used in part (c).

e. Compute the overall return of this strategy using the same range of final stock prices.
4. Was the broker correct that the protective put would prevent your uncle from losing if the announcement caused a large decrease in the stock value? What is your uncle’s maximum possible loss using the protective put?
5. What is the maximum possible loss your uncle could experience using the straddle?
6. By how much does Walmart’s stock price need to increase for your uncle to come out ahead using the straddle versus the put?