Question

Question 6 You are given the following data on call and put premiums in pence per share for Company ABC shares which are currently priced in the market at 311 pence. Each contract refers to 1000 to shares. Put premiums in pence Call premiums in pence September September Strike Prices 300 pence 330 pence 61 48 44 60 i. You expect the share price to rise to 400 pence discuss a speculative strategy and the profits/losses at a range of different prices for the underlying share in September ii. You own 1000 shares in Company ABC and fear that the share price might fall to 200 pence. Discuss a hedging strategy using the above contracts and the approximate value of your net hedged position at a range of different prices for the underlying share in September.

Answer 1

i]

If you expect share price to rise, call options of 330 strike price should be bought.

Payoff of a long call option = Max[S-X, 0] - P

S = underlying price at expiry,

X = strike price

P = premium paid. This is 48 pence.

Payoff of each contract is for 1000 shares, hence the payoff is multiplied by 1000 to get the payoff of the contract.

2 3 6 AB Payoff (in pence) Stock price at Long Call expiry (330) 250 (48,000) 260 (48,000) 270 (48,000) 280 (48,000) 290 (48,000) 300 (48,000) 310 (48,000) 320 (48,000) 330 (48,000) 340 (38,000) 350 (28,000) 360 (18,000) 370 (8,000) 380 2,000 390 12,000 400 22,000 410 32,000 420 42,000 430 52,000 440 62,000 450 72,000 460 82,000 470 92,000 102,000 480

Payoff (in pence) Stock price at expiry 250 260 270 Long Call (330) =(MAX[A3-330,0)-48)* 1000 =(MAX(A4-330,0)-481 1000 =(MAX[A5-330,0)-48)* 1000 =(MAX(A6-330,0)-48)* 1000 =(MAX[A7-330,0)-48)* 1000 =(MAX[A8-330,0)-48)* 1000 =(MAX[A9-330,0)-48)* 1000 =(MAXIA 10-330,0)-48)" 1000 =(MAXIA11-330,0)-48)* 1000 =(MAXIA 12-330,0)-48) 1000 =(MAXIA 13-330,0)-48)* 1000 =(MAX[A14-330,0)-48) 1000 =(MAX(A15-330,0)-48)* 1000 =(MAX[A16-330,0)-48)* 1000 =(MAX[A17-330,0)-48)* 1000 =( MAXIA 18-330,0)-48)* 1000 =( MAXIA 19-330,0)-48)* 1000 =(MAXIA20-330,0)-48) 1000 =(MAXTA21-330,0)-48) 1000 =(MAX[A22-330,0)-48)* 1000 =(MAX[A23-330,0)-48)* 1000 =(MAX[A24-330,0)-481 1000 =(MAX[A25-330,0)-48)* 1000 =(MAX[A26-330,0)-48)* 1000 23 450 24 460 25 470 26 480

ii]

A covered call is appropriate strategy.

Call option with 300 strike price should be sold.

1000 shares are owned, and each option contract is for 1000 shares.

Payoff of a sold call option = P - Max[0, S-X]

S = underlying price at expiry,

X = strike price

P = premium received. This is 61 pence.

4 A C D B Payoffs 6 7 Stock Profit/loss price at on shares Short Call Net 2 expiry owned ($300) Payoff 250 ($61,000) 48,000 # ## 260 ($51,000) 48,000 ($3,000) 270 ($41,000) 48,000 $7,000 280 ($31,000) 48,000 $17,000 290 ($21,000) 48,000 $27,000 300 ($11,000) 48,000 $37,000 310 ($1,000) 38,000 $37,000 10 320 $9,000 28,000 $37,000 330 $19,000 18,000 $37,000 12 340 $29,000 8,000 $37,000 350 $39,000 (2,000) $37,000 14 360 $49,000 (12,000) $37,000 370 $59,000 (22,000) $37,000 380 $69,000 (32,000) $37,000 390 $79,000 (42,000) $37,000 400 $89,000 (52,000) $37,000 410 599,000 (62,000) $37,000 420 $109,000 (72,000) $37,000 430 $119,000 (82,000) $37,000 440 $129,000 (92,000) $37,000 450 $139,000 (102,000) $37,000 13 15

B 290 Payoffs Stock price at Profit/loss on shares 2 expiry owned 3 250 =1000* (A3-311) 4 260 =1000*(A4-311) 5 270 =1000*(A5-311) 6 280 =1000*(A6-311) =1000*(A7-311) =1000*(A8-311) =1000* (A9-311) =1000*(A10-311) =1000*(A11-311) =1000*(A12-311) =1000*(A13-311) =1000*(A14-311) =1000*(A15-311) =1000* (A16-311) 17 390 =1000*(A17-311) 18 400 =1000*(A18-311) 19 410 =1000* (A19-311) 20 420 =1000-(A20-311) 21 430 =1000*(A21-311) 22 440 =1000-(A22-311) =1000-(A23-311) Short Call ($300) ={48-MAX(0, A3-300))*1000 =(48-MAX(0,A4-300))*1000 =(48-MAX(0,A5-300))*1000 =(48-MAX(0,A6-300))*1000 =(48-MAX(0,A7-300))*1000 =(48-MAX(0,A8-300))*1000 =(48-MAX(0,A9-300))*1000 =(48-MAX(0,A10-300))*1000 =(48-MAX(0,A11-300))*1000 =(48-MAX(0,A12-300))*1000 =(48-MAX(0,A13-300))*1000 =(48-MAX(0, A14-300))*1000 =(48-MAX(0,A15-300))*1000 =(48-MAX(0,416-300))*1000 =(48-MAX(0, A17-300))*1000 =(48-MAX(O, A18-300))*1000 =(48-MAX[0, A19-300))*1000 =(48-MAX(0, A20-300))*1000 =(48-MAX(0,A21-300))*1000 =(48-MAX(0,A22-300))*1000 = [48-MAX[0, A23-300))*1000 Net Payoff =B3+C3 =B4+04 =B5+C5 =B6+06 =B7+07 =B8+C8 =B9+09 =B10+C10 =B11+C11 =B12+C12 =B13+C13 =B14+C14 =B15+C15 =B16+C16 =B17-C17 =B18+C18 =B19-C19 =B20+C20 =B21+C21 =B22-C22 =B23+C23 23 450