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Investing Assignment 6

In: Business and Management

Submitted By stefa1104
Words 754
Pages 4
Problems M06

Case Problem P14.2

I reckon that the benefit of using the put as a hedge device is that he will be able to sell the stock at 75 per share in the next three months. The market price of the stock does not matter. This guarantees a minimum return to Luck by using the put option. If the market price of the stock remains at 75 or above, the put option will not be utilized and the premium paid on the put option will go waste.
Luck's minimum profit assuming option is exercised:
Selling Price per share: 75
Less purchase cost per share: 40
Less option premium per share: 5.5
Net profit per share: 75 - 45.5 or 29.5 per share
Total profit: $8,850

If he did not purchase options and sell the stock immediately at 75, he would make 35 dollars per share (75 - 40 dollars) or $10,500 of total profit.

With a stock that drops to 50 per share, he will exercise the option and sell the stock at 75 dollars per share to make a total of 8,850.
With a stock that increases up to 100, he will let the options expire and sell the stock directly in the market at 100 per share to make a total profit of:
$100 - $40 purchase price and $5.5 options premium or 100 - 45.5 or 54.5 per share profit or total of $16,350 in profits.

I reckon that his best option is to use put as an hedge to lock in minimum profits from the transaction. We have to analyze this situation/option in a scenario where market conditions are volatile and the investor is less optimistic about the future of the stock and the potentiality of the market. Conversely, he could avoid using put as an hedge if he believes in the potential of the stock and the current market.

Problem P 15.2

Computation of the Market value of the contract
Market value of contract = Price X quantity

Price 88.8
Quantity 50,000
The price quote of 88.8 implies 88.8 cents per pound.

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