Nick Fitzgerald holds awell-diversified portfolio ofhigh-quality, large-cap stocks. The current value ofFitzgerald's portfolio is $735,000, but he is concerned that the market is heading for a big fall(perhaps as much as20%) over the next three to six months. Hedoesn't want to sell any of his stocks because he feels they all have goodlong-term potential and should perform nicely once stock prices have bottomed out. As aresult, he's thinking about using index options to hedge his portfolio. Assume that theS&P 500 currently stands at 2,200 and among the many put options available on this index are two that have caught hiseye: (1) asix-month put with a strike price of 2,150 that's trading at $75.00, and(2) asix-month put with a strike price of 2,075 that's quoted at $59.00.

a. How manyS&P 500 puts would Nick have to buy to protect his $735,000 stockportfolio? How much would it cost him to buy the necessary number of puts with a $2,150 strikeprice? How much would it cost to buy the puts with a $2,075 strikeprice?

b. Now, considering the performance of both the put options andNick's portfolio, determine how much net profit(or loss) Nick will earn from each of these put hedges if both the market(as measured by theS&P 500) andNick's portfolio fall by 20% over the next six months. What if the market andNick's portfolio fall by only 10%? What if they go up by 5%?

c. Do you think Nick should set up the put hedgeand, ifso, using which putoption? Explain.

d. Finally, assume that the DJIA is currently at 17,550 and that asix-month put option on the Dow is available with a strike price of 174, and is currently trading at $7.84. How many of these puts would Nick have to buy to protect hisportfolio, and what would theycost? Would Nick be better off with the Dow options or theS&P 2,150 puts? Briefly explain.