CASE VI

Delphi Capital Management (DCM) is an investment management firm which, inter alia, offers portfolio management service to high networth individuals. Avinash Joshi, managing director of DCM, realized that many clients have interest in using options, but often do not understand the risks and rewards associated with these instruments.

You have joined DCM about six months ago. After majoring in finance you worked for a well known securities firm where you received good exposure to derivative instruments, before joining DCM. Appreciating your expertise, Avinash Joshi has asked you to educate and guide clients interested in using options

You have been approached by Pradeep Sharma, an eminent surgeon and long-time client of DCM, who wants to understand about options and the strategies based on options. You have decided to use the following data to Newage Hospitals Limited, a company in which Pradeep Sharma has equity shares, to guide him.

Newage Hospitals Option Quotes

Stock Price : 325
		Calls Puts
Strike Price	Jan	Feb	March	Jan	Feb	March
280 300 320 340 360	48 34 15 5 2	53 38 18 8 4	- 41 20 14 5	- 2 6 17 -	- 4 9 19 40	- 6 - 21 -

To educate your client you have to develop answers for the following questions:

What do the following terms mean: call option, put option, strike price (exercise price), and expiration date?

Which options are in the-money and which options are out of-the- money?

Assume that Pradeep Sharma owns 1000 shares of Newage Hospitals. What are the relative pros and cons of selling a call against this position using (i) January/340 versus (ii) March/300

What is the maximum profit, maximum loss, and break-even price associated with the strategy of simultaneously buying March/340 call while selling March/360 call?

What are the implications for Pradeep Sharma if he simultaneously writes March/340 call and buys March/300 put?

What is the profit at various stock prices of a March/340 straddle? Give the answer in the form of a graph.

What impact do the following have on the value of a call option?

Current price

Exercise price

Options term to maturity

Risk-free rate

Variability of the stock price

What assumptions underlie the Black-Scholes option pricing model?

What are the three equations that constitute the Black-Scholes model?

What should be value of the March/320 call as per the Black-Scholes model? Assume that t = 3 months, r_f=6 percent, and 0=0.30.

What is a collar?