You are an investor and has strong reasons to believe 2 fundamental analysts' forecasts on XYZ. One is of the opinion of a share price increase and the other believes that the share price would decline by the close of the financial year owing to uncertainty in interest rates. You wish to sell your shares just before the close of the financial year to reap advantage of another dividend payout, which is almost a certain event. You have so far made an unrealised profit, having bought the shares at $20.00 on March 1. Today is April 30.XYZ stock volatility is 25%, and currently trades at $24.50. The table below shows calls and puts on the stock that expires at the end of June (end of financial year). Strike 23 23.5 24 24.5 25 Call 2.02 1.67 1.36 1.09 0.85 0.66 Put 0.35 0.49 0.68 0.91 1.17 1.47 25.5 (a) What would be the cheapest method to secure as much unrealised profits as possible using these options, given the likely price movements of the stock? You are also required to work out the break-even point. (5 marks) Hint: Optimal strategy, gaining most marks, is to offset the cost as much as possible of the insurance and the unrealised gain. (b) Demonstrate, using some of the options data above, how writing a naked put is similar to holding a synthetic covered call position. (3 marks) (c) name two purposes for creating a synthetic option. (2 marks) You are an investor and has strong reasons to believe 2 fundamental analysts' forecasts on XYZ. One is of the opinion of a share price increase and the other believes that the share price would decline by the close of the financial year owing to uncertainty in interest rates. You wish to sell your shares just before the close of the financial year to reap advantage of another dividend payout, which is almost a certain event. You have so far made an unrealised profit, having bought the shares at $20.00 on March 1. Today is April 30.XYZ stock volatility is 25%, and currently trades at $24.50. The table below shows calls and puts on the stock that expires at the end of June (end of financial year). Strike 23 23.5 24 24.5 25 Call 2.02 1.67 1.36 1.09 0.85 0.66 Put 0.35 0.49 0.68 0.91 1.17 1.47 25.5 (a) What would be the cheapest method to secure as much unrealised profits as possible using these options, given the likely price movements of the stock? You are also required to work out the break-even point. (5 marks) Hint: Optimal strategy, gaining most marks, is to offset the cost as much as possible of the insurance and the unrealised gain. (b) Demonstrate, using some of the options data above, how writing a naked put is similar to holding a synthetic covered call position. (3 marks) (c) name two purposes for creating a synthetic option. (2 marks)
