TUTORIAL 12

Options
Loss = 15 – Spot + 0.10
Loss = Spot – 20 + 0.60
◦ A) Function of option market

◦ Options used to manage the risk and offer speculators a way to leverage
their investment with a strict limit on downside risk.

◦ b) In the money. Call price = RM8

◦ a) Value = zero

◦ b) Strike price is higher than stock price and the option would not be exercised.

◦ c) Return = [ 6 - (4 + 1.60) ] / 1.60 = 0.40/1.60 = 25%

◦ d) Advantages:
◦ - Lower cost of investment
◦ - Leverage – potential magnification of gains
◦ - Losses limited only to the amount of premium paid
◦ - Possible lower transactions cost for portfolio as a whole
◦ - Can be used as a hedging tool

◦ e) A buyer who agrees to purchase an item at contract maturity has a long position. The seller who agrees to
deliver the item at contract maturity has the short position.
 4) An investor bought a March 2010 put option on Fiver Corp
with a strike price of RM5.00 at a premium of RM1.20 when the
stock price of Fiver Corp was RM5.50.

◦ a) Calculate the value of the put option on the expiry date of the option if the stock price of
Fiver Corp remains at RM5.50. Explain your answer.

◦ b) Assuming that the put option was exercised when the stock price of Fiver Corp was at
RM3.00, calculate the percentage return on the investment.

◦ c) Explain how an investor could hedge his investment in a share by purchasing a put option.

◦ d) Discuss the difference between hedgers and speculators in the futures markets.
◦ a) Value = zero. Strike price is lower than stock price and the option would not be exercised.

◦ b) Return = (5 – 3 – 1.20) / 1.20 = 0.80/1.20 = 66.67%

◦ c) The investor owns the share and will make a profit if the share increases in value or make a lost if the price
decreases. However, by buying a put option he may exercise the put option and sell his share at the
predetermined exercise price. The predetermined price has thus become the minimum price that the investor is
able to sell his share. The amount that he received from exercising the put option can then be used to offset his
losses in the underlying share. This would limit his potential loses which means a hedged has been done.

◦ d) Hedgers face the risk of buying or selling commodities or financial instruments before entering the futures
markets. Hedgers enter the futures markets in an attempt to reduce an already existing risk. Speculators face no
risk before entering the futures market. They enter the futures market in expectation of making a high returns like
a gambler.