Reference no: EM132764448
Question - You are currently managing a stock portfolio worth $55 million, and you are concerned that over the next four months, equity values will be flat and may even fall. Conse-quently, you are considering two different strategies for hedging against possible stock declines: (1) buying a protective put and (2) selling a covered call (selling a call option based on the same underlying stock position you hold). An over-the-counter derivatives dealer has expressed interest in your business and has quoted the following bid and offer prices (in millions) for at-the-money call and put options that expire in four months and match the characteristics of your portfolio:
Bid Call
Put $2.553 1.297
Ask $2.573 1.31
a. For each of the following expiration date values for the unhedged equity position, cal-culate the terminal values (net of initial expense) for a protective put strategy.
35, 40, 45, 50, 55, 60, 65, 70, 75
b. Draw a graph of the protective put net profit structure in part (a) and demonstrate how this position could have been constructed by using call options and T-bills, assuming a risk-free rate of 7 percent.
c. For each of these same expiration date stock values, calculate the terminal net profit values for a covered call strategy.
d. Draw a graph of the covered call net profit structure in Part c, and demonstrate how this position could have been constructed by using put options and T-bills, again assuming a risk-free rate of 7 percent.
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