Assume that the common stock of Luther Industries is currently traded for 47 per share. The stock pays no dividends. A 3-month European call option on Luther with a strike price of 45 is currently traded for 7.45. The risk-free rate interest rate is 2% per year. Assume that you own common stock of Luther Industries, but you are concerned about a decline in its stock price in the near future.

a) Should you simply sell your holding? Why or why not? (4 %)

b) Evaluate hedging the downside risk with options. What type of option should you use? Be specific, and show this strategy at maturity in a position diagram. (10 %)

c) Suppose that put options on Luther Industries are not traded, but you want to have one. How could you achieve it? (Hint: design a strategy that uses a combination of financial securities) (8 %)

d) Suppose that put options on Luther Industries stocks are traded. What noarbitrage price should a 3-month European put option on Luther Industries with an exercise price of 45 sell for? (8 %)

e) What is the minimum profit of your portfolio after you purchase this put option? (3 %)