(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 derivative 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 optins that expire in four months and match the characteristics of your portfolio:
Call $2.553 $2.573
Put 1.297 1.317
(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) For each of these same expiration date stock values, calculate the terminal net profit values for a covered call strategy.
These solutions may offer step-by-step problem-solving explanations or good writing examples that include modern styles of formatting and construction of bibliographies out of text citations and references. Students may use these solutions for personal skill-building and practice. Unethical use is strictly forbidden.Answer (a):
In protective put strategy, put options are purchased on the equity portion so that if there is decline in the stock prices, the losses can be compensated by gains in options market.
Current value of equity position = $55 million
Since the put option is at the money, strike price of the option = $55 million
Premium paid to buy the put option = $1.317 million...
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