Options as Insurance Instruments

Clearly, given that options allow their owners to take certain financial actions in favor of their portfolio objectives, they can be thought of as financial insurance: if the price of the underlying assets moves in an unfavorable direction, the option can be exercised to restrict the losses to be experienced. The value of this form of insurance is affected by both the dynamics of the underlying assets and the type of option used. The overall insurance value of an option is defined by no-arbitrage restrictions on option prices and largely by the exercise time of the option.

You will explore the concept of options as insurance for a financial investment. To Prepare: Review this weeks Learning Resources, as well as other resources you may access and the Internet. Consider the following: In what way(s) are calls a form of financial insurance, as opposed to puts? What information about options and/or their underlying assets would users of options need to determine their insurance value?

Post by Day 3 a 4- to an 8-paragraph analysis of the insurance value of options. Make sure to include responses to the following specific questions:

#1 How is the insurance value of an option determined by the difference between the cost of an option and the cost of a synthetic portfolio? Provide a numerical example.

#2 What factors can make the insurance value of an American option be much greater than that of its European equivalent?

#3 Is there any information that can be derived from the markets on what the insurance value of options is for their actual users (in other words, can we tell who hedges and who speculates with options)? C

learly address each of the questions with 13 paragraphs. Make sure you use APA style for your response(s) and properly cite any resources you have used