Question 3

Dose Pharma Limited is facing a court dispute on the side effects of its Coved19 vaccines. As the judgement day is approaching soon, it will have 5,000 shares of this company. If the judgement falls in favour of this company, its share prices will have a large swing upwards and if otherwise, its share price may face a large swing downwards. Currently its shares are selling at $40 each. To hedge on uncertain movement of share price, it is planning to buy a call and a put on these shares at the money strike maturing on the same time. As it is at the money strike each call costs $8 and put costs $6.

a. What option hedge strategy will create?

b. Describe clearly how would he implement this strategy?

c. What is it betting on? The direction or volatility?

d. Construct a table that shows the payoff for each option, the total payoff and profit points.

e. What will be its total profit or loss if the share price would swing up or down by 40% of the strike price?