Adapted from Corporate finance Jonathan Berk, Peter DeMarzo, 3rd ed., Data Case Chapter 20

Your uncle owns 10,000 shares of Wal-Mart stock. He is concerned about the short-term outlook for Wal-Marts stock due to an impending major announcement. This announcement has received much attention in the press, so he expects the stock price will change significantly in the next month, but is unsure whether it will be a profit or a loss. He hopes the price will increase, but he also does not want to suffer if the price were to fall in the short term. His broker recommended he buy a protective put on the stock, but your uncle has never traded options before and is not much of a risk taker. He wants you to devise a plan for him to capitalize if the announcement is positive but to still be protected if the news causes the price to drop. You realize that a protective put will protect him from the downside risk, but you think a straddle may offer similar downside protection, while increasing the upside potential. You decide to show him both strategies and the resulting profits and returns he could face from each.

1. Download option quotes on options that expire in approximately one month on Wal-Mart from the Chicago Board Options Exchange (www.cboe.com) into an Excel spreadsheet (click the Quotes & Data tab at the top left portion of the screen and then select Delayed Quotes). If you choose to download near term at-the-money options you will get a range of options expiring in about a month. Note: You can only get active quotes while the exchange is open; bid or ask prices are not available when it is closed.

2. Determine your uncles profit and return using the protective put.

a. Identify the expiring put with an exercise price closest to, but not below, the current stock price. Determine the investment required to protect all 10,000 shares.

b. Determine the put price at expiration for each stock price at $5 increments within a range of $40 of Wal-Marts current price using equation 1.

c. Compute the profit (or loss) on the put for each stock price used in part (b).

d. Compute the profit on the stock from the current price for each stock price used in part (b).

e. Compute his overall profit (or loss) of the protective put, that is, combining the put and his stock for each price used in parts (c) and (d).

f. Compute the overall return of the protective put.

at t = 0 with near the money option

near the money option at approximately one month expiration

detailed data to take $5 increments at T = 0

continued table

detailed data to take $5 increment at time of expiration

continued table