The COVID-19 Pandemic has resulted in country wide lockdowns and non-essential business closures all around the world. The stock market index has responded to the coronavirus fears with large drops. As of March, 17, the S&P 500 fell nearly 30% compared to its record peak set less than a month ago.

Though the stock market index has responded to unprecedented shock with large drops, not all industries/companies are impacted to the same extent. For instance, essential businesses such as the supermarkets have also seen a temporary boost in sales from "panic buying". As Bloomberg reported, one New Zealand-based 'supermarket chain said it sold enough food in a single day to feed 10 million people.'

You are a hedge fund manager, one of your clients overheard that option contracts may an insurance to the investments and asks your opinions about this.

Question

a.Explain to your client how option contract can be used as protection against a fall in stock price.

b. SPDR S&P 500 EFT trust option (SPY) is designed to track the value of S&P 500. Suppose a one-month call option with a strike price of $300 costs $11.5; a one-month put option with a strike price of $310 costs $7.5, your client bought two call options and two put option, what is the breakeven stock price below which that the client makes a profit?

c. Costco (NASDAQ: COST) proving its strength as a consumer staples stalwart and has seen its share price strongly outperform the S&P 500 over the last month. Suppose you have purchased a Costco stock, which type of option should be chosen for hedging? Based on the option you selected, choose the appropriate strike price to calculate the option price, assuming the Costco is on a non-dividend-paying stock and the current stock price and strike price are given in the question, the risk-free interest rate is 3% per annum, the volatility is 30% per annum, and the time to maturity is four months.

COST Date Stock Expiration Date Strike Price 1 Strike Price 2 Price Call Oct 05, 20 355 OCT 30, 2020 340 380 Put Oct 05, 20 355 OCT 30, 2020 340 380 0