Assume that the common stock of Luther Industries is currently traded for 47 per share. The...

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Assume that the common stock of Luther Industries is currentlytraded for 47 per share. The stock pays no dividends. A 3-monthEuropean call option on Luther with a strike price of £45 iscurrently traded for £7.45. The risk-free rate interest rate is 2%per year. Assume that you own common stock of Luther Industries,but you are concerned about a decline in its stock price in thenear future.
a) Should you simply sell your holding? Why or why not?
b) Evaluate hedging the downside risk with options. What type ofoption should you use? Be specific, and show this strategy atmaturity in a position diagram.
c) Suppose that put options on Luther Industries are not traded,but you want to have one. How could you achieve it? (Hint: design astrategy that uses a combination of financial securities)
d) Suppose that put options on Luther Industries stocks aretraded. What noarbitrage price should a 3-month European put optionon Luther Industries with an exercise price of £45 sell for?
e) What is the minimum profit of your portfolio after youpurchase this put option?

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3.6 Ratings (367 Votes)

a 3month european call with strike price 45 is trading at 745 and the underlying stock is trading at 47 Theoretically speaking the call price is a function of intrinsic value and time value of money In this case the intrinsic value is 4745 2 and time value of money is 545 TV also indicates towards the market outlook and looking at the TV value it See Answer

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Assume that the common stock of Luther Industries is currentlytraded for 47 per share. The stock pays no dividends. A 3-monthEuropean call option on Luther with a strike price of £45 iscurrently traded for £7.45. The risk-free rate interest rate is 2%per year. Assume that you own common stock of Luther Industries,but you are concerned about a decline in its stock price in thenear future.a) Should you simply sell your holding? Why or why not?b) Evaluate hedging the downside risk with options. What type ofoption should you use? Be specific, and show this strategy atmaturity in a position diagram.c) Suppose that put options on Luther Industries are not traded,but you want to have one. How could you achieve it? (Hint: design astrategy that uses a combination of financial securities)d) Suppose that put options on Luther Industries stocks aretraded. What noarbitrage price should a 3-month European put optionon Luther Industries with an exercise price of £45 sell for?e) What is the minimum profit of your portfolio after youpurchase this put option?