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Eason, a portfolio manager, has just purchased a stock at $1,300 per share which he believes to have promising prospect. To protect against losses, Eason
Eason, a portfolio manager, has just purchased a stock at $1,300 per share which he believes to have promising prospect. To protect against losses, Eason plans to purchase an at-the-money European put option on the stock for $70, with exercise price $1,300, and three-month time to expiration. Alternatively, as Eason feels that he may be spending too much on this put, he could also buy a three-month put with strike price of $1,270 which costs only $55.
- Analyze the two hedging strategies by drawing the profit diagrams for the stock-plus-put positions for various values of the stock in three months. (14 marks)
- When does the strategy with cheaper put do better? When does it do worse? (4 marks)
- Why are the prices of the puts different? (2 marks)
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