Options are often used in combination with stocks to reduce risk or to produce other avenues of revenue. Buying protective puts guards against downside risk while allowing for upside potential. Writing covered calls allow investors to earn premium income on a stock they expect to remain stable in price. Wang Foo Ltd. has a current stock price of $80, does not pay dividends, and has an expected standard deviation of .30. Also, the risk-free rate is 10% per year, continuously compounded. The price of a European call option contract of 100 shares is $1,726.39. The price of a European put option contract of 100 shares is $220.60. 4. What will be the payoff and profit of the protective put if the stock price on maturity is $60, $70, $76, $80, $86?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
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Options are often used in combination with stocks to reduce risk or to produce other avenues of revenue.
Buying protective puts guards against downside risk while allowing for upside potential.
Writing covered calls allow investors to earn premium income on a stock they expect to remain stable in price.
Wang Foo Ltd. has a current stock price of $80, does not pay dividends, and has an expected standard deviation of .30. Also, the risk-free rate is 10% per year, continuously compounded.
The price of a European call option contract of 100 shares is $1,726.39.
The price of a European put option contract of 100 shares is $220.60.
4. What will be the payoff and profit of the protective put if the stock price on maturity is $60, $70, $76, $80, $86?
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