A
Vitalik Buterin, the co-founder and inventor of the decentralized open-source blockchain Etherium, 3 currently has a portfolio of cryptocurrency worth USD800 million (including about 350,000 Ether, or ETH, the cryptocurrency generated by the Ethereum protocol). The portfolio also has an income yield of 0.5% per annum with simple compounding. Vitalik has seen the value of his portfolio significantly decline over the first half of 2022, due in large part to the latest 'crypto winter'. 4 He expects the bear market to end before the year is out, but he is worried that there will be further falls before then. As such, he has approached your institution for advice on how best to protect the value of his existing crypto portfolio over the next 6 months. He also does not want to miss out on any potential upside if the crypto market starts to rise sooner than he expects. You know just the derivative for the job and suggest that a position in Ether (ETH) options will provide the desired protection. Since Vitalik's portfolio is highly correlated with Ether prices, options on Ether can be used as a portfolio hedge (in the same way that stock index options can be used to hedge an equity portfolio). To this end, you estimate from historical price data that the 'Ether beta' 5 of Vitalik's portfolio is 1.4. You also note that Ether does not pay any income (and hence has a zero income yield) and that the risk-free interest rate in the US is currently 3.1% per annum with simple compounding for all maturities. The current spot price of Ether is USD1,485 and the following table provides the market prices (in USD) for various European call and put options written on Ether with different strikes and (a) Describe the options portfolio insurance strategy that would insure against Vitalik's cryptocurrency portfolio falling below USDSOO million over the next six months. 6 Explain why this strategy fulfils his request and why hedging with Ether futures does not suffice. Also, highlight some of the potential downsides of the strategy if implemented in practice. Vitalik Buterin, the co-founder and inventor of the decentralized open-source blockchain Etherium, 3 currently has a portfolio of cryptocurrency worth USD800 million (including about 350,000 Ether, or ETH, the cryptocurrency generated by the Ethereum protocol). The portfolio also has an income yield of 0.5% per annum with simple compounding. Vitalik has seen the value of his portfolio significantly decline over the first half of 2022, due in large part to the latest 'crypto winter'. 4 He expects the bear market to end before the year is out, but he is worried that there will be further falls before then. As such, he has approached your institution for advice on how best to protect the value of his existing crypto portfolio over the next 6 months. He also does not want to miss out on any potential upside if the crypto market starts to rise sooner than he expects. You know just the derivative for the job and suggest that a position in Ether (ETH) options will provide the desired protection. Since Vitalik's portfolio is highly correlated with Ether prices, options on Ether can be used as a portfolio hedge (in the same way that stock index options can be used to hedge an equity portfolio). To this end, you estimate from historical price data that the 'Ether beta' 5 of Vitalik's portfolio is 1.4. You also note that Ether does not pay any income (and hence has a zero income yield) and that the risk-free interest rate in the US is currently 3.1% per annum with simple compounding for all maturities. The current spot price of Ether is USD1,485 and the following table provides the market prices (in USD) for various European call and put options written on Ether with different strikes and (a) Describe the options portfolio insurance strategy that would insure against Vitalik's cryptocurrency portfolio falling below USDSOO million over the next six months. 6 Explain why this strategy fulfils his request and why hedging with Ether futures does not suffice. Also, highlight some of the potential downsides of the strategy if implemented in practice
