Identify the strategy employed by Dumo above.  Protective Put Tabulate the Profit to the strategy at expiration for the following    Exercise price R30; Stock price 20. Exercise price R30; Stock price 35.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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  • Dumo is a trader at ZNF Equity traders and has just identified a stock, UFSI Limited, which is currently trading at R25 per share. Dumo decides to take a long position in at-the money put option and simultaneously buys one share of UFSI stock. The put option expires in 3 months’ time and costs R2.5 per share. Assume a contract consists of one put option.

Required:

  1. Identify the strategy employed by Dumo above. 

Protective Put

  1. Tabulate the Profit to the strategy at expiration for the following   
  2. Exercise price R30; Stock price 20.
  3. Exercise price R30; Stock price 35.
Expert Solution
Question 1:

The strategy employed by Dumo is protective put investment strategy. A protective put position is formed by purchasing a stock and purchasing put options on the share-for-share origin.

Question 2:

I) The computation of profit as follows:

Exercise price 30, stock price 20

For long position (purchase) in Put option,

Pay off from long position in stock:

Hence, the profit is R 2.5.

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