Suppose the price of UK Sports plc shares on the London Stock Exchange is 860p on February 18^th 2022.

1. As an investor, you believe that UK Sports plc will be subject of a takeover and that you are targeting a price of 950p. To profit from this view, you decide to buy September 840 call options at 45p (each option = 1,000 shares).

Write out the payoff table showing profits and losses on one September 840 call option.

1. Suppose instead that you currently own 1,000 shares of UK Sports. You are concerned that the takeover rumours may be false and that the share price might fall.

You decide to use a September 840 put option to hedge this risk. This costs 20p.

Using a payoff matrix, use any two scenarios of falling prices to illustrate how this

'protective put' strategy provides an effective hedge.

Briefly explain why this protective put strategy may be preferable to selling the shares.

Answer rating: 100% (QA)

Payoff Table for September 840 Call Option Underlying Price UK Sports plc Share Price Call Option Pr... View the full answer