Hypothetical starting value for S&P 500 index: 2800; Dividend yield: 1.80 (contin. compounded, annualized); risk-free 6-month interest rate: 2.50% (contin. compounded, annualized). Assume that 6- month European calls and puts on the S&P 500 index can be bought or written at any desired strike price, where the Black-Scholes model provides the fair value for the options. Assume that the implied volatility of the index for pricing the options is 15% annualized. Ignore any considerations of margin requirements for the derivative contracts.

Consider the following possible ELS. The terminal cash flows for the ELS would occur in 6 months and depend upon the value of the S&P 500 index in 6 months. Assume that the options and SPY ETF can be transacted in any integer amount, and that the ELS has a multiplier of 100 times the S&P 500 index (which would be 1000 times the SPY).

1. If you are the issuer of this ELS, what should be your holdings of options and the SPY ETF to generate the future cash flows for the above ELS? For simplicity, assume that the issuer keeps the dividends from the underlying index over the life of the contract as the spread, so that the ELS can be offered at a price based on the current fair values of the options and ETF.