Critical Commentary, Payoff Calculations, And Option Strategies In Finance
Business Objectives and Shareholder Value
Answer to Question 1
While reaching the revenue and profitability aids in boosting the morale of the members of the organisation, to sustain the changes in the immediate environmental factors, and to gain the acceptance from the customers and the suppliers. In addition, it is required to maintain the cash flow and the credit worthiness of the entity, by paying the invoices and the short-term dues in a timely manner. The long-term profitability is an indicator of growth, stability and the efficient utilisation of assets of the enterprises. Moreover, the long-term shareholder value creation aids in overall achievement of the goals and the vision of the entity. Thus, it has been correctly said that the managers must create a healthy balance between maximisation of the long-term shareholder value and the short-term returns.
Answer to Question 2
|
Particular of Options |
Price |
Strike Price |
Difference |
|
Buy the Call |
40 |
32 |
0 (lapse) |
|
Buy the Call |
30 |
32 |
2 (Profit) |
|
Sell the Call |
35 |
32 |
0 (lapse) |
|
Sell the Call |
35 |
32 |
0 (lapse) |
|
Net Payoff |
– |
– |
2 |
Answer to Question 3
The highest payoff from this position is the profit of $ 20. The lowest payoff from this position is loss of $ 10.
Answer to Question 4
The position as mentioned above would arise when the share price would reach to either $ 40 or $30, i.e. the individual no profit, no loss position.
Answer to Question 5
It has been rightly said that corporate managers must uphold the ethical standards in achieving the goal of maximising the shareholder value. In order to sustain the business in long run, the mangers must cater to the needs of all the stakeholders, namely the customers, community, employees, suppliers, regulators and more. The same cannot be achieved by entering into unethical arrangements, which can be beneficial from the point of view of generation of finance, but not from the point of view of the stakeholders. Some of the basic values that must be integrated by the financial managers in the operations of the entity are integrity, objectivity, and care and due diligence.
Answer to question 6-
|
Call options |
Strike price |
Difference |
|
Buy the call at 40 |
32 |
0 (option will be lapsed) |
|
Sell the call at 50 |
32 |
0 (option will be lapsed) |
|
Net payoff |
– |
0 |
The highest pay off from this position is the profit of 10 $. The lowest pay off from this position is the loss of 10 $. Further, the position as mentioned above would arise when the share price would fail to 0 $.
Answer to question 7
There is limited risk in the long option. On the other hand, the short option has indefinite risk. The long put and short call both make the stock short. Moreover, these options have various sensitivities to the risk elements. The long put refers to the insurance. The premium is required to pay in long put option, which is maximum probable net loss in the exchange of opened payout. Further, the short call refers to the income strategy. The premium is obtained in the exchange of possibility of hypothetically unrestricted loss (Bhatt & Karandikar, 2015).
In this way, profit curve is not similar (wherever, profit = payoff – premium). The option of short call has huge loss or negative profit potential. While, the option of long put does not loss more than premium. However, it has practically opened gain potential.
Payoff Calculation for Call Options
Answer to Question 8
Yes, the original position is closed by buying a call as well as a put option at the same exercise price, i.e. $ 50. However, the total cost of closing the position is the difference of both the premiums, i.e. $ 6 (14.5-8.5).
Answer to Question 9
Computation of profits from the straddle on January 21.
|
Particular of Options |
Price |
Strike Price |
Difference |
|
Exercise Put |
50 |
45 |
5 (Profit) |
|
Cost of Straddle |
11 |
– |
11 (Cost) |
|
Net Payoff |
– |
– |
6 (Loss) |
Answer to question 10
Hedge funds are typically much less framed, and less formal. The hedging option has few tiers and titles. Some hedges are costly even if marketplace stay neutral. Many investors do not like when the corporations have hedges. In the case where hedging is not useful, the pressure by investors may lead to the corporation reversing course and eliminating hedges (Wicaksono, Arissaputra & Rufaidah, 2018).
Answer to question 11
|
Put |
EP |
Assumed stock price on expiry |
OP |
Profit/loss |
|
|
buy |
45 |
70 |
– 0.5 |
Lapse |
0 |
|
buy |
50 |
70 |
-6 |
Lapse |
0 |
|
sell |
55 |
70 |
10 |
Lapse |
0 |
|
Net profit |
3.5 |
0 |
Answer to question 12
Computation of current present value of option
Value = 50e^-.10 =50*.90901=45.45
Since there is a difference between the current price and the current value, the arbitrage opportunity exists.
Answer to question 13
Computation of current present value of option
Value = 60e^-.10 =60*.90901=54.54
Since there is difference between the current price and the current value, the arbitrage opportunity exists.
Answer to Question 14
No, this is not an effective strategy. If the fall in the stock price is expected, the trader should buy a put option at strike price of 100 $and sell the put option at the strike price of 95 $. If the investor goes along0with the current strategy, he will incur the loss if his apprehensions about the price decline prove right.
Answer to Question 15
The exchange rate risk because of increase in the Canadian Dollar, to be paid on the import can be avoided by hedging. Hedging can be done by investing in the respective currency forwards, currency futures, or the currency options. The hedging can also be done using the hedged exchange traded funds.
Answer to question 16-
Strip- The strip is indefinite profit. It refers to the restricted risk option trading approaches that are used in the case where the basic price of stock will experience important instability in the respective term.
Strip construction: Buy 1 Call and,
Buy 2 Puts.
Strap- It is a modified version of common straddle. The strap includes purchasing the number of puts and twice the number of calls having similar exercise price and expiration date.it is indefinite profit. They are restricted risk options strategies which are used when basic stock price will experience key instability in the relative term and is more likely to assembly upwards in the place of downwards.
Strap construction: Buy 2 Calls and,
Buy 1 Put.
Risk reversal- the risk reversal refers to the strategy of hedging. It secures the short position and long position with the use of call option and put option. The option of risk reversal is used to secure in contradiction of adverse price movements in underlying position. However, it controls the profit, which may be made over this position.
Collar- the collar refers to the options trading strategy. It is made by holding shares of original stock while concurrently purchasing defensive put and selling calls in against this share holding. It is used to restrict the downside risk of held underlying protection.
Answer to question 17
|
Stock with stop loss at 10% |
Fixed deposit @5% |
||
|
Value of investment at the beginning |
990000 |
10000 |
Value of investment |
|
Value of investment at the closing |
891000 |
10500 |
901500 |
Answer to question 18
Yes, this is an effective strategy. If the rise in the stock price is expected, with the current strategy, he will earn a profit if his apprehensions about the price rise prove right.
Answer to question 19
Computation of current present value of option
Value = 60e^-.10 =60*.90901=54.54
Since there is difference between the current price and the current value, the arbitrage opportunity exists.
Answer to question 20
|
PARTICULARS |
CP |
EP |
PREMIUM |
Actual Price |
POSITION |
AMOUNT |
|
GOLD |
$ 290 |
$ 250 |
LOSS |
($ 40) |
||
|
CALL OPTION |
$ 310 |
$ 10 |
$ 250 |
LAPSE |
($ 10) |
|
|
PUT OPTION |
$ 280 |
($ 9) |
$ 250 |
$ 21 |
||
|
TOTAL |
|
|
|
|
|
($ 9) |
Answer to question 21
|
PARTICULARS |
CP |
EP |
PREMIUM |
ACT PRICE |
POSITION |
AMOUNT |
|
FUEL |
$ 0.50 |
$ 0.55 |
LOSS |
($ 0.05) |
||
|
CALL OPTION |
$ 0.55 |
$ 0.04 |
$ 0.55 |
NP/NL |
$ 0.04 |
|
|
PUT OPTION |
$ 0.45 |
($ 0.06) |
$ 0.55 |
LAPSE |
$ (0.06) |
|
|
TOTAL |
($ 7) |
Answer to question 22
|
PARTICULARS |
CP |
EP |
PREMIUM |
ACT PRICE |
POSITION |
AMOUNT |
|
CORN FLAKES |
$ 3 |
$ 2.05 |
LOSS |
$ 0.95 |
||
|
CALL OPTION |
$ 3.50 |
$ (0.12) |
$ 2.05 |
LAPSE |
$ (0.12) |
|
|
PUT OPTION |
$ 2.50 |
$ 0.12 |
$ 2.05 |
LOSS |
$ (0.33) |
|
|
TOTAL |
$ 0.50 |
Answer to question 23
Computation of Value = 50e^-.10
=50*.90901=54.54
Here current price is 50 and current value is approximately 54. There is difference between the current price and the current value. Hence, the arbitrage opportunity is possible.
Answer to question 24
Calculation of possibility of arbitrage-
Current Value = 5e^-.10
=5*.90901
= 4.54
The current price is 5 and current value is approximately 4.54. There is difference between the current value and the current price. So, the arbitrage opportunity is possible.
Answer to question 25
Currently, exchange rate is 104 yen per USD. The interest rate in Japan is 1% while it is 5% in USA. Applying Interest rate parity theory, one year forward rate could be worked out to be 100.04 [(104*(1+1%)/(1+5%)]. The forward rate is decreasing which implies that USD is depreciating against yen or vice a versa. The company has receivables in yen; so, it would be beneficial for the company if they receive the amount in coming one year. There is no risk of foreign exchange loss.
However, the company has taken a call option on yen to provide safeguard against foreign exchange loss. The exercise price of call option is 175. The decision to take call option at exercise price of 175 is not beneficial to the company, as it will result in exchange loss.
Reference
Bhatt, A. G., & Karandikar, R. L. (2015). On the fundamental theorem of asset pricing. Communications on Stochastic Analysis, 9(2), 7.
Wicaksono, A., Arissaputra, R., & Rufaidah, P. (2018). Development Global Competitive Advantage at PT Tiphone Mobile Indonesia, Tbk Case Study using 4C’s Framework Model. International Journal of Applied Business and International Management, 3(1), 27-45.