Question 2

You own 50,000 shares in X PLC but you think the price might fall by 10% in the next month. However, you do not want to sell the shares, as this will incur a large tax bill. You decide to buy a protective put to offset the possible loss in the value of the shares. You obtain the following information: the current share price of X PLC is 2 per share and put options with a strike/exercise price of 1.90 with an expiry date next month cost 5p each.

1. How many put options should be bought to offset all of expected loss from the shareholding?

9 marks

b. If the share price actually falls to 1.95 what is the loss to your overall share and option portfolio?

9 marks

c. Briefly explain why greater price volatility of an underlying share makes an option based on that share more valuable.

7 marks

(Total: 25 Marks)