Question

Section 1 (10 points each) 1. Options can be used either to leverage up and increase portfolio risk, or alternatively to reduce overall portfolio risk. Describe an example of a risk-increasing option strategy. and describe an example of a risk-decreasing option strategy, and briefly explain each. 2. You are a portfolio manager and you are considering buying a large put option on your existing portfolio. Why would you do this and what is the basic trade-off you must consider in your decision whether to do this or not?

Answer 1

question 1:

a. A portfolio manager can increase the leverage by using Option strategy in the following way.
If the portfolio manager is already holding stocks- he can buy call options on the stock.

(Or)

The option Strategy like Long Strap can be useful.
Where he buys 2 call options & 1 put option.

b. A portfolio manager can decrease the leverage by using Option strategy in the following way.

If the portfolio manager is already holding stocks- he can buy put options on the stock.

Or
The option Strategy like Long Strip can be useful.

Where he buys 1 call options & 2 put option.

Question 2. There is a crash phobia in the market. The market can fall at any time, so to protect and hedge themselves, almost all the big institutional investors (portfolio managers) buy put option at large quantity. The strike price to lower bottom.  

(Like for example if Index is currently at 10,000.
Then put option strike price is at 7000 or 7500. )

After the stock market crash of 2008, systematic failure fear has increased, promoting more institutional investors to buy the put options.