You are a pension fund manager. Today is May. You OWN 100 shares of SPX. Today's

SPX share price is $3,330 per share.

There exist call and put options with an expiration date of June 11. Each option is on one share of SPX.

The call has an exercise price of $3400 and a premium of $3.00 per share.

The put has an exercise price of $3200 and a premium of $4.00 per share.

The riskless interest rate is zero and that SPX will not pay dividends over the life of the options.

a)  Design a hedging (insurance) strategy against a SUBSTANTIAL DECLINE in the share price using either put or call options. Calculate the initial cost and the maximum loss on expiration day, per share.

b)  You are concerned about the high cost of the insurance provided by the strategy.Using the options above, design a hedging strategy that will cost less money today and will have lower maximum losses on expiration day. 

Calculate the initial cost, and the maximum gains and losses on expiration day, per share.

c)  Compare the two strategies above. Which strategy is better? EXPLAIN.

Answer rating: 100% (QA)

a To hedge against a substantial decline in the share price you could buy put options A put option gives the buyer the right but not the obligation to ... View the full answer