Case study- Derivatives and risk management

Ram, who has been trading in futures that resulted in huge losses, is now convinced that trading in options is a better alternative to trading in futures when the direction of price movement is uncertain. However, he would like to know what gains he can make if he enters into options contracts. He has collected the following details on options on Tata Steel stock. On September 1, Tata Steel shares are selling at INR 430. Call options and put options are available on Tata Steel with an exercise price of INR 450 and an exercise date of October 28. A call is priced at INR 30, and a put is priced at INR 50. The contract size is 764. The analysts have estimated that the share price of Tata Steel could be anywhere in the range of INR 380 to INR 520. Ram wants answers to the following questions: Discussion Questions 1. If he purchases a call option, what will be the initial outlay for him? 2. If he writes a call, what will be the initial receipt for him? 3. What will be his initial premium margin (i) if he buys a call and (ii) if he writes a call? 4. If he purchases a put option, what will be the initial outlay for him? 5. If he writes a put, what will be the initial receipt for him? 6. What will be the initial premium margin for (i) if he buys a put and (ii) if he writes a put? 7. Show diagrammatically what will be Rams gains for the price range of INR 380 to INR 520 on the exercise date if: (i) he buys a call (ii) he buys a put (iii) he writes a call (iv) he writes a put 8. Which of these four strategiesbuying a call, writing a call, buying a put, and writing a putwill be appropriate for different price ranges? 9. Suppose Tata Steel announces a dividend of INR 15 on October 10 with a holder-of-record date of October 15, so that the stock will go ex-dividend on October 16. On October 15, the share price of Tata Steel is INR 462. Should Ram exercise the call option? Should he exercise the put option?