Reference no: EM133003838
Questions based on HEDGING.
Suppose investor holds an investment in the S&P 500 on 200 shares. The current spot price of the index is $3520/share. Afraid that the COVID-19 rally will fade, the investor has three alternatives: 1) keep stock and enter a futures contract for expiry 18-Dec-2020 to sell 200 shares of stock at the price of $3500/share, 2) keep stock and enter the following option combination involving two different option contracts (buy 2 contracts of a put with strike 3300, expiry 18-Dec2020, for $100/share, and sell 2 contracts of a call with strike of $3700/share, 3 expiry 18-Dec-2020, for $100/share), 3) keep stock and enter the following option combination involving two different option contracts (buy 2 contracts of a put with strike 3400, expiry 18-Dec-2020, for $120/share and sell 1 contract of a call with strike of $3400/share, expiry 18-Dec-2020, for $240/share. Recall 1 option contract is struck on 100 shares.
QUESTIONS:
1. Compute the total portfolio value (net value in price per share for stock investment plus/minus net option payoffs) under three scenarios at the option maturity date of 18-Dec-2020: a) S&P 500 ends at $5000/share, b) S&P 500 ends at $3600/share, c) S&P 500 ends at $2500. This is a quantitative response.
2. The option combination involved in strategy 3 is called a 'participating futures' contract. Show this is the best strategy if S&P 500 ends at $5000/share. Give the intuition as to why this strategy is called a 'participating futures' contract. Compare the hedging outcome versus strategy 1, which involves the standard futures contract. This is a two part question requiring both quantitative and qualitative responses.
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