Chapter 20, Problem 1PS

Summary Introduction

To explain: Examples of risk-increasing and risk-reducing options techniques to scale up or reduce overall portfolio risk.

Introduction: Options are used to supervise the portfolio risk. They can boost the risk as well as diminish it. There are two categories of options one is risk increase and the second is a risk decrease option.

Answer to Problem 1PS

The optional example of a risk-increasing option is at the money option while the protective put strategy is an example of a risk-reducing option technique.

Explanation of Solution

Given Information: Here a statement is provided that options are used to raise and reduce the portfolio risk.

Risk-increasing options- This technique boots up the level of portfolio risk while investing in particular folio, for example, at the money option. In this option the value of expiration will be null, hence it equates the asset price with an exercise price. These options are very risky but profitable also.

Risk-reducing options- This option reduces the risk with protection, for example, a protective put strategy. Investors invested in this option in the long run because the strike price is either lower than the market price or higher. The risk is reduced with full security of value in a particular portfolio.