Reference no: EM131974033

Question: It is February 2017. You have formed a consortium of Monash University finance alumni and your group, currently called Finance Fanatics, is planning a significant investment in six months. You will be required to contribute $40,000. Fortunately, you now have an excellent job working in financial markets and spent your undergraduate and postgraduate time trading shares rather than partying and so you have $40,000 invested in BHP shares (1,000 shares at $40 per share).

You would rather not sell your portfolio immediately because you are now on a high tax rate but plan to travel overseas in nine months by taking unpaid leave of absence and will earn less so you would prefer to sell the shares in the new financial year and pay less tax.

However, you are conscious that you are exposing yourself to the risk that the price of your BHP shares may fall. You are also saving money to go overseas and have calculated that if the value of your portfolio of BHP shares falls by more than 10% (to less than $36,000) you will have to postpone your travels. You also realise that if the value of the portfolio increases, you can afford to spend more time in London and New York. To manage this risk, you are considering three alternative strategies:

1. Write six-month call options on BHP shares with a strike price of $44.

2. Buy six month put options on BHP with a strike price of $36.

3. Write six month calls and buy six month puts to create a zero-cost collar.

Six month $36 puts and $44 calls are both currently trading at $3.

Ignore any interest accruing or paid on option premiums over this period.) For each strategy, evaluate how well it meets your investment target and determine the advantages and disadvantages.