Question
Mr. Strong is a portfolio manager of an investment bank. He is planning to sell 100,000 shares of Apple stock for his wealthy client, Mr.
Mr. Strong is a portfolio manager of an investment bank. He is planning to sell 100,000 shares of Apple stock for his wealthy client, Mr. Weak. The current stock price of Apple is $40. Mr. Weak would like to defer selling the stock until March next year because he is optimistic about the future prospect of Apple. However, Mr. Weak is also worried about the price risk involved in keeping his shares until March. At current price, Mr. Weak would receive $4,000,000 for the stock. If the value of his stock holdings falls below $3,000,000 in March next year, Mr. Strong would not be able to buy his dream house. Mr. Strong is evaluating two hedging strategies for Mr. Weak:
a. Strategy A is to write March call options (i.e. short call) on Apple shares with strike price $45. These call options are currently selling for $3 each.
b. Strategy B is to buy March put options (i.e. long put) on Apple shares with strike price $35. These put options are also selling for $3 each.
Evaluate these two strategies with respect to the need of Mr. Weak to buy his dream house. Explain which strategy Mr. Strong should recommend.
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