Solved: Nick Fitzgerald holds a well diversified portfolio of

high quality large cap stocks

Nick Fitzgerald holds a well-diversified portfolio of high-quality, large-cap stocks. The current
value of Fitzgerald's portfolio is $735,000, but he is concerned that the market is heading for a
big fall (perhaps as much as 20%) over the next three to six months. He doesn't want to sell all
his stocks because he feels they all have good long-term potential and should perform nicely
once stock prices have bottomed out. As a result, he's thinking about using index options to
hedge his portfolio. Assume that the S&P 500 currently stands at 2,200 and among the many
put options available on this index are two that have caught his eye:

(1) A six-month put with a strike price of 2,150 that's trading at $76, and

(2) A six-month put with a strike price of 2,075 that's quoted at $58.

a. How many S&P 500 puts would Nick have to buy to protect his $735,000 stock portfolio?
How much would it cost him to buy the necessary number of puts with a $2,150 strike price?
How much would it cost to buy the puts with a $2,075 strike price?

b. Now, considering the performance of both the put options and Nick's portfolio, determine how
much net profit (or loss) Nick will earn from each of these put hedges if both the market (as
measured by the S&P 500) and Nick's portfolio fall by 15% over the next six months. What if the
market and Nick's portfolio fall by only 5%? What if they go up by 10%?

c. Do you think Nick should set up the put hedge and, if so, using which put option? Explain.

d. Finally, assume that the DJIA is currently at 17,550 and that a six-month put option on the
Dow is available with a strike of 174, and is currently trading at $7.84. How many of these puts
would Nick have to buy to protect his portfolio, and what would they cost? Would Nick be better
off with the Dow options or the S&P 2,150 puts? Briefly explain.

Nick Fitzgerald holds a well diversified portfolio of high quality large cap stocks

ANSWER
https://solvedquest.com/nick-fitzgerald-holds-a-well-diversified-portfolio-of-high-quality-large-cap-
stocks/

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