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You wish to insure a portfolio for 1 year. Suppose that S = $100, = 30%,

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You wish to insure a portfolio for 1 year. Suppose that S = $100, σ = 30%, r = 8%, and δ = 0. You are considering two strategies. The simple insurance strategy entails buying one put option with a 1-year maturity at a strike price that is 95% of the stock price. The rolling insurance strategy entails buying one 1-month put option each month, with the strike in each case being 95% of the then-current stock price.
a. What is the cost of the simple insurance strategy?
b. What is the cost of the rolling insurance strategy?
c. Intuitively, what accounts for the cost difference? 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. Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest... Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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a 60831 b The current price of a 1m 95strike put is 12652 In fact a 1m put with a strike equal to 95 ...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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