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| we say that the options can be used either to scale up or reduce overall portfolio risk. What are some examples of risk-increasing and risk-decreasing option strategies? Explain each. |
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| 1. Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk is investing in an ‘all options’ portfolio of at the money options (as illustrated in the text). The leverage provided by options makes this strategy very risky, and potentially very profitable. An example of a risk-reducing options strategy is a protective put strategy. Here, the investor buys a put on an existing stock or portfolio, with exercise price of the put near or somewhat less than the market value of the underlying asset. This strategy protects the value of the portfolio because the minimum value of the stock-plus-put strategy is the exercise price of the put. |
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| why do you think the most actively traded option tend the ones that are near the money? |
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| 2. Options at the money have the highest time premium and thus the highest potential for gain. Since they highest potential gain is at the money, the logical conclusion is that they will have the highest volume. A common phrase used by traders is “avoid the cheaps and the deeps.” Cheap options are those with very little time premium. Deep options are those that are way out of or in the money. None of these provide profit opportunities. |
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the following price quotations are for exchange-listed options on Primo Corporation common stock
Strike: 55
Expiration: Feb
Call: 7.25
Put: .48
With transaction costs ignored, how much would a buyer have to payfor one call option contract? |
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| 3. Each contract is for 100 shares: $7.25 100 = $725 |
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You purchase one IBM March 100 put contract for a premium of $6.47. what is your max profit?
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| 5. If the stock price drops to zero, you will make 96.14 – 6.47 per stock, or 89.67. Given 100 units per contract, your total potential profit is $8,967. |
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| An investor buys a call at a price of $4.50 with an excercise price of $40. At what stock price will the investor break even on the purchase of the call? |
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| 6. Break even = 40 + 4.50 = 45.50 |
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You establish a straddle on Intel using September call and put options with a strike price of $50. The call premium is $4.25 and the put premium is $5.00
a- what is the most you can lose on this position?
b- what ill be your profit or loss if Intel is selling for $58 in sept
c- At what stock prices will you break even on the straddle |
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| 7. a. Maximum loss = 4.25 + 5.0 = 9.25 b. Profit / loss = 58 – 50 – 9.25 = -1.25 c. There are two break even prices: 59.25 and 40.75 |
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| 8. c is the only correct statement. |
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Consider the following portfolio. You write a put option with exercise price $90 and buy
a- put with the same expiration date with excercise price $95
b- Plot the value of the portfolio at the expiration date of the options |
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| A put option with strike price $60 trading on the Acme options exchange sells for $2. To your amazement, a put on the firm with the same expiration selling on the Apex options exchange but wih strike price $62 also selling $2. If you plan on holding option position until expiration, devise a zero-net-investment arbitrage strategy to exploit the pricing anomaly. Draw the profit diagram at expiration for your position. |
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