Question 1 (40 marks)

The Post Covid-19 Pandemic has disrupted the performance of many business entities. Depending on the core business activity of a company, the continuity of its business is highly uncertain. This case highlights two companies in Malaysia that fall into this uncertain circumstance. First is the XIVO Corporation, which operates a fleet of inbound and outbound tours, hotels, restaurants and entertainment outlets. Second is the RK Corporation, which produces surgical rubber gloves, face masks and deals with various types of medical equipment.

Generally, the market sentiments for listed company shares have been bearish since the Covid-19 pandemic. However, the businesses that are involved predominantly in healthcare have achieved downtrend movements in their stock prices while the businesses that are involved in tour and entertainment have seen stock prices increases.

RK Corporations shares are currently trading at RM3.50 per share while XIVO Corporation shares are trading at RM9.00 per share. RK Corporations share prices had recorded a 15% drop in the last 4 weeks and had dropped about 60% since last year. XIVO Corporations shares have recorded a 20% increase in the last 4 weeks and have appreciated by about 450% since last year.

Assume that you represent a financial institution that can trade options contracts and you have gathered information on both these firms. Based on the Sept 2023 European Options trading data on both these firms (which will expire on 30^th Sept 2023), you are required to strategize the best options trading which can provide profit at lowest possible cost.

Sept 2023 Option Prices: RK Corp. Sept 2023 Option Prices: XIVO Corp.

Strike Price (RM)	Call Price (RM)	Put Price (RM)		Strike Price (RM)	Call Price (RM)	Put Price (RM)
3.00	0.25	0.45		8.50	0.98	0.33
3.25	0.22	0.55		8.75	0.90	0.45
3.50	0.18	0.65		9.00	0.75	0.55
3.75	0.15	0.90		9.25	0.65	0.70
4.00	0.12	1.05		9.50	0.55	0.85
4.25	0.10	1.12		9.75	0.50	0.90
4.50	0.08	1.25		10.00	0.45	1.02

Based on the current market conditions and the option prices in the tables above, you are required to:

1. Design the appropriate vertical option spreads strategy for each firm that could limit the cost and cap a reasonable profit. (hint: choose in-the-money, at-the money or out-the money)(strategies used (not 100% correct): bear put strategy for RK and bull car strategy for XIVO)

(10 marks)

1. Show the appropriate spread diagrams supported by its payoff tables.

(20 marks)

1. Provide a brief explanation on how your spread strategies in part (a) can be profitable.

(10 marks)