Due to the political uncertainty brought by the 15th General Election, most of the financial research houses have forecasted that the market would have high volatility, especially for government related stocks. Your friend, Elaine, is holding 100,000 shares of ABC Building Bhd., which is a construction firm that bids for government projects. She would like to seek your advice on how she can protect the profit of her shareholding with options for the next 3 months.

The options information is as follows:

Stock price : RM8.20

Time to maturity : 90 days

Interest rate : 3.5%

Volatility : 25%

Contract size : 100 shares

Option (expiring in 90 days)	Price
Price Put option with an exercise price of RM8.20	RM0.40
Call option with an exercise price of RM8.20	RM0.50

(a) Outline the strategy to hedge Elsa's shareholding with options and compute the payoff if the stock price of Build Materials Bhd. rises to RM8.80 after 180 days.

(b) Based on the strategy in part (a) above, justify whether Elsa is buying the option at a fair value by using the Black-Scholes Option Pricing Model (BSOPM).

(c) Another speculator has an opinion that is different from yours, and he believes that the war will end soon which will then lead to a huge rebound of the stock markets. As a risk-averse investor, justify a speculation strategy and compute the payoff profile based on the two conflicting points of view

Answer rating: 100% (QA)

a Strategy to Hedge Elaines Shareholding Elaine can use a protective put ... View the full answer