AB Ltd, operating in the gaming industry in Hong Kong, was established six years ago, and the two founder directors still provide the necessary technical and marketing skills. They own 60% of the company stocks, the balances plus the long-term loan capital having been subscribed by a firm of venture capitalists. H plc, in the hotel business. H plc, in the hotel business,is considering a take-over bid for the stocks of AB Ltd.

 

You are acting as a financial advisor to AB Ltd. The managing director of the company approached you, to seek advice on the characteristics and use of traded options to protect itself against a fall in the value of its company being a potential acquisition. Assume the currently is 31 December 2021, the stock price of AB Ltd is HK$2.87 and traded options on its stocks are available as follows (all figures in cents HK$):

 

Strike price	Calls January	March	Puts January	March
280	8.5	16.0	1.5	10.5
290	2.5	11.0	5.5	16.0

 

Assume that the options above expire at the end of the relevant month and the premiums are payable upfront. Ignore the interest implications of premium payment. Assume AB's stock price would be HK$2.50 on 31 March 2022.

 

 

1. Compute the intrinsic value and time value of each of the options on AB Ltd's stocks as of 31 December 2021. 

 

1. Identify and discuss 3 factors that impact the time value of the options and 2 factors that impact the intrinsic value of the options on AB Ltd's stocks.

 

1. Suggest how AB Ltd can protect itself against a fall in the stock price in the period up to 31 March 2022 when H plc decides whether to make an offer for AB Ltd. Show all calculations.