Question

The following strategies were discussed in the video lecture on options strategies. Given the following scenarios, indicate which strategy you would use and why. Strategies Protective Put Covered Call Spread Straddle Collar 1. As part of your inheritance, you received shares of stock in a company as part of a trust fund. You are restricted from selling the shares of stock for five years. You don't think that the firm is being managed well and that the price will fall prior to the end of the five year period. What option strategy could you use to protect yourself from the loss in value? (3 points) 2. You run a mutual fund and you have decided that the most that Apple Inc. stock is worth is $270 and you plan to sell the stock when it reaches that point. What option strategy could you take to make additional income if your belief is correct? (3 points) 3. You believe that Microsoft stock is going to increase in price from $147 to $160 in the next six months. You want to purchase call options to take advantage of the increase in price, but can't afford the full price of the options. What strategy would be best for this situation? 4. The Walt Disney Company's foray into streaming services presents a situation that will result in a large stock price increase could occur if the venture is successful, or a large loss if it is not. If the streaming service, Disney+, does well, the stock price is expected to increase by 30%. If the service is not well received, Disney's stock price is expected to fall by 30%. Which option strategy would be the best strategy to make a profit from this situation? (3 points)

Answer 1

Q1) Protective put

Reason :- The price of the shares may decrease which can only be protected by buying put option and also maintaining the right to sell because there is a restriction on the sale for five years.

Q2) Collar

Reason :- The collar option comprises of protective put and covered call. In this case we are long the put option and short the call option. As the person wants sell the stock , he can do it by buying put option and can earn additional income through premium on call option.

Q3) Spread

Reason :- Spread means buying and selling same options at different strike price or different expiration date. In this case we buy call and sell call option on same number of shares. Buying of call option will be profitable as the price increases from 147 to 160, and selling the call option will provide you with income to afford the options.

Q4) Straddle

Reason :- It consists of buying both put and call option. This is most useful if there can be movement in any direction and we are not sure of it. This explanation coincides with the situation in the question , so we should use this strategy. As the price increase call option is exercised and as the price decrease we excersice put option.