Question 3.1

A company announces that it is changing the focus of its business operations from a relatively more cyclical and volatile industry to a relatively less cyclical and volatile industry. The share market reacts positively to this news, simultaneously increasing the companys share price and reducing its volatility. Both call and put options are traded on the companys shares.

3.1.1 All else being the same, what is the most likely overall effect of the above changes on call option prices? Provide a brief explanation.

3.1.2 All else being the same, what is the most likely overall effect of the above changes on put option prices? Provide a brief explanation.

Q3.2 Question 3.2

You sold short 2,000 shares of a company for $40.00 per share in May 2022. You are worried about the market turning bullish, so you decide to buy 20 call options on the companys shares with each contract written on 100 shares at an exercise (or strike) price of $40.00 expiring in July 2022 for a premium of $2.00 per share.

3.2.1 What is the rationale behind entering this call option hedge? Explain.

(Answer parts 3.1 and 3.2 independently of each other)