Reference no: EM132494553

(a) As a result of the current COVID-19 pandemic, stock markets around the globe have become volatile. As an investor you perceive that the markets are going to experience significant movements in the near future; however, you are not sure about the direction of such movements. The markets may go up or go down. In such uncertain circumstances, what type of option strategy would you recommend to follow? Explain why.

(b) The common stock of the ABC Corporation has been trading in a narrow range, around $50 per share for months, and you believe it is going to stay in that range for the next three months. The price of a 3-month put option with an exercise price of $50 is $4.

(i) if the risk-free rate is 10% per year, what must be the price of a 3-month call option on ABC stock at an exercise price of $50 if it is at the money? (Assume put-call parity holds and the stock pays no dividend).

(ii) What would be a simple option strategy using a put and call to exploit your conviction about the stock price's future movements? Explain clearly.

(iii) How far can the stock price move in either direction before you lose money?