# Question

You are currently managing a stock portfolio worth $55 million and you are concerned that over the next four months equity values will be flat and may even fall. Consequently, you are considering two different strategies for hedging against possible stock declines:

(1) buying a protective put, and (2) selling a covered call (i.e., selling a call option based on the same underlying stock position you hold). An over-the-counter derivatives dealer has expressed interest in your business and has quoted the following bid and offer prices (in millions) for at-the-money call and put options that expire in four months and match the characteristics of your portfolio:

a. For each of the following expiration date values for the unhedged equity position, calculate the terminal values (net of initial expense) for a protective put strategy.

35, 40, 45, 50, 55, 60, 65, 70, 75

b. Draw a graph of the protective put net profit structure in Part a, and demonstrate how this position could have been constructed by using call options and T-bills, assuming a risk-free rate of 7 percent.

c. For each of these same expiration date stock values, calculate the terminal net profit values for a covered call strategy.

d. Draw a graph of the covered call net profit structure in Part c, and demonstrate how this position could have been constructed by using put options and T-bills, again assuming a risk-free rate of 7percent.

(1) buying a protective put, and (2) selling a covered call (i.e., selling a call option based on the same underlying stock position you hold). An over-the-counter derivatives dealer has expressed interest in your business and has quoted the following bid and offer prices (in millions) for at-the-money call and put options that expire in four months and match the characteristics of your portfolio:

a. For each of the following expiration date values for the unhedged equity position, calculate the terminal values (net of initial expense) for a protective put strategy.

35, 40, 45, 50, 55, 60, 65, 70, 75

b. Draw a graph of the protective put net profit structure in Part a, and demonstrate how this position could have been constructed by using call options and T-bills, assuming a risk-free rate of 7 percent.

c. For each of these same expiration date stock values, calculate the terminal net profit values for a covered call strategy.

d. Draw a graph of the covered call net profit structure in Part c, and demonstrate how this position could have been constructed by using put options and T-bills, again assuming a risk-free rate of 7percent.

## Answer to relevant Questions

The common stock of Company XLT and its derivative securities currently trade in the market at the following prices and contract terms:Both of these options will expire 91 days from now, and the annualized yield for the ...You are the chief financial officer of a large multinational company, and six months from now you will be receiving a settlement payment of $50 million, which you plan to invest in 10-year U.S. Treasury bonds. Your interest ...You are a coffee dealer anticipating the purchase of 82,000 pounds of coffee in three months. You are concerned that the price of coffee will rise, so you take a long position in coffee futures. Each contract covers 37,500 ...The treasurer of a middle market, import-export company has approached you for advice on how to best invest some of the firm's short-term cash balances. The company, which has been a client of the bank that employs you for a ...Explain why a change in the time to expiration (i.e., T) can have either a positive or negative impact on the value of a European-style put option. In this explanation, it will be useful to contrast the put's reaction with ...Post your question

0