Assume that you hold 1,000 shares in Company X, and your shareholding is worth 4,210 (i.e. 421p per share). You are afraid the share price might drop but at the same time you don't want to sell your shares. There is a put option contract (on 1000 shares) available with an exercise price of 395p and a premium of 25p per share.

a)If you want to hedge your shares against the potential decline in the share price, would you buy an option or would you type (write) an option? (no need to explain)

b) Assuming that the share price falls to 350p by maturity, what will be the intrinsic value of the options?

c) Draw a graph showing the profits and losses from the option at share prices ranging from 350p to 450p. (Hint: ignore the profits/losses from the shares in this part, just show the profits/losses from the options.)

d) What will be your total profit/loss if the share price drops to 340p? (Hint: in this part you should consider the profits/losses from everything including shares and options.)

Answer rating: 100% (QA)

a To hedge your shares against the potential decline in the share price you would ... View the full answer