The common stock of the R.U.I.T. Corporation has boon trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next three months. You do not know whether it will go up or down, however. The current price of the stock is
a. What would be a simple options strategy to exploit your conviction about the stock price’s future movements?
b. How far would the price have to move in either direction for you to make a profit on your initial investment?
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Essentials Of Investments
- The common stock of the C.A.L.L. Corporation has been trading in a narrow range around $50per share for months, and you believe it is going to stay in that range for the next 3 months. Theprice of a 3-month put option with an exercise price of $50 is $4.a. If the risk-free interest rate is 10% per year, what must be the price of a 3-month call optionon C.A.L.L. stock at an exercise price of $50 if it is at the money? (The stock pays nodividends.)b. What would be a simple options strategy using a put and a call to exploit your convictionabout the stock price’s future movement? What is the most money you can make on thisposition? How far can the stock price move in either direction before you lose money?c. How can you create a position involving a put, a call, and riskless lending that would havethe same payoff structure as the stock at expiration? What is the net cost of establishing thatposition now?arrow_forwardStanton Company stock is trading for 50 in a two‑time period environment, so that each relevant time period is 6 months. The stock might increase by exactly 20% in just one period or perhaps in both periods. Of course, the stock might not increase in either period. If the stock price does not increase in a given period, it will decline by 16.67 percent in that particular period. One-year options with an exercise price equal to 60 are trading on this stock. The annual riskless rate of return equals 0. a. What is the value of a put in this environment? b. What is the probability (risk-neutral probability) implied in this framework that the Stanton Company stock price will exceed 40 when options expire?arrow_forwardThe stock of Suncor Energy is currently trading for $36 per share. An investor expects the stock price to move up in the next two months, and decided to invest $7, 200 in this stock. If the investor invests all the money in the stock, how much is the profit or loss if the stock price in two months turns out to be i) 40 or ii) 32? If the investor invests all the money in call options with a strike price of $35 and price of the call is $2 per share, how much is the profit or loss if the stock price in two months turns out to be i) 40 or ii) 32?arrow_forward
- Imagine that you are holding 5,000 shares of stock, currently selling at $40 per share. You are ready to sell the shares but would prefer to put off the sale until next year for tax reasons. If you continue to hold the shares until January, however, you face the risk that the stock will drop in value before year-end. You decide to use a collar to limit downside risk without laying out a good deal of additional funds. January call options with a strike of $45 are selling at $2, and January puts with a strike price of $35 are selling at $3. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at: (a) $30, (b) $40, or (c) $50? Compare these proceeds to what you would realize if you simply continued to hold the shares.arrow_forwardYou think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($19.00 bid and $20.00 ask), and you want to maximize the amount of profit from your investment. So, you will use a margin account to borrow on margin in order to buy as many shares as you can. Your initial margin requirement is 45%, and you have $90,000 of your own money to invest in the shares. The minimum (maintenance) margin is 30%, and Fleetwood does not pay dividends. (Ignore interest for this problem.) If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy? Suppose you bought the maximum number of shares of Fleetwood as in (1). Assume that immediately after your purchase, Fleetwood’s share price drops to $18.00 per share. Calculate your new margin. Will you receive a margin call? How far can the price drop before you will receive a margin call? If the stock price falls to $14.00, you calculate that you would…arrow_forwardMomo, a fast-growing company, will make an earnings announcement three months from now. But you do not know whether it will be positive or negative (i.e., the stock price will go up or down). The current price of the stock is $30 per share. A three-month call with an exercise price of $30 costs $5. A put with the same exercise price and expiration date costs $5. a. What would be a simple options strategy to bet on the stock price volatility?arrow_forward
- Momo, a fast-growing company, will make an earnings announcement three months from now. But you do not know whether it will be positive or negative (i.e., the stock price will go up or down). The current price of the stock is $30 per share. A three-month call with an exercise price of $30 costs $5. A put with the same exercise price and expiration date costs $5. Buy three month call option @Strike price $30 ; pay premium $5 Buy three month put option @Strike price $30 ; pay premium $5 Total premium paid =$5+$5 = $10 b. Construct a table and a graph to show the profit/loss (P/L) from the option strategy.arrow_forwardYou expect the price of a stock to increase by 20% in the following year, with a standard deviation of 30%. The stock currently trades at $50. You pursue a strategy of buying 100 shares of the stock on margin. The initial margin requirement is 50%. The annual interest on margin debt is 5% per year. (a) What is the expected return and standard deviation of your strategy? (assume there is no margin call.) (b) The maintenance margin is 30%. Six months after you establish your trade, you receive a margin call. What is the price of the stock when this happens?arrow_forwardAmazon’s stock price is currently $3,084 and call options with exactly 3 months to expiration and an exercise price of $3,100 are quoted at $208. The 3-month T-bill rate is currently 0.75% and the stock does not pay dividends. Based on this information, what is the implied standard deviation of Amazon stock returns, in annual terms, over the next 3 months? Please calculate by hand.arrow_forward
- You just purchased a share of stock in ABC Corporation, at a cost of $1,400. Your broker has indicated that there’s a 25% probability that the stock will end the year at a price of $1,000, a 60% probability that it will end at $2,000 is .60, and a 15% probability that it will end at $5,000. Calculate the mean, variance, and standard deviation for theinvestment’s end-of-year anticipated dollar value. In your view, is this a wise investment? Why or why not?arrow_forwardCarmax, Inc. common stock currently sells for $106.45 per share, and the standard deviation of returns is 44.91%. A call option with a strike price of $95.00 is currently trading on the market. The option expires in three months, and the risk-free rate of return is 2.6%. Carmax does not pay a dividend. Carmax's gamma (Γ) is: Group of answer choices 0.00391 0.01353 0.01526 0.01541arrow_forwardThe shares of XYZ Inc. are currently selling for $120 per share. The shares are expected to go up by 10 percent or down by 5 percent in each of the following two months (Month 1 and Month 2). XYZ Inc. is also expected to pay a dividend yield of 2 percent at the end of Month 1. The risk-free rate is 0.5 percent per month. a. What is the value of an American call option on XYZ shares, with an exercise price of $125 and two months to expiration? Use the binomial model to obtain the answer. b. Draw a binomial tree diagram for this American call option, showing the share price, call price, and whether the call should be exercised at each state during the next two months. ***Answer b onlyarrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT