Omega Analytics provides risk management consulting for institutional and individual clients. Rachel Osborne, CFA, is an investment advisor for Omega who works with the firm’s larger accounts. She is considering derivative strategies for several clients.
HMM Foundation owns 30,000 shares of Nasdaq 100 Index Tracking Stock (Symbol: QQQQ), which has a current price of $30 per share. Osborne believes there is substantial risk of downside price movement in the index over the next six months. She recommends HMM use a six-month collar for the entire position of 30,000 shares as protection against the QQQQ price falling below $27. Exhibit 1 illustrates current QQQQ puts and calls expiring in 6 months.
Exhibit 1
QQQQ Puts and Calls Expiring in Six Months
Option Type
|
Exercise Price ($)
|
Option Premium ($)
|
Call
|
35
|
0.80
|
Put
|
27
|
0.95
|
HMM would hold the collar strategy until expiration of the put and call options.
Bob Valentine believes the prices of large capitalization stocks will rise slightly and he wants to profit from this movement using a bull spread strategy. Osborne recommends Valentine use Dow Jones Industrial Average (DJX) options expiring in two months. The current price of DJX is $91. Exhibit 2 illustrates current option information for two DJX call options expiring in two months.
Exhibit 2
DJX Call Options Expiring in Two Months
Exercise Price ($)
|
Option Premium ($)
|
Delta
|
88
|
4.40
|
0.75
|
94
|
1.00
|
0.30
|
Valentine decides to use 100 contracts per position. Each contract is equal to 100 shares.
The Bedford Trust is focused on long-term growth and invests only in equities. The trust has an equity portfolio with a market value of $60 million, of which $20
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million is allocated to WTO stock. Its trustees are considering a temporary decrease in the allocation to WTO stock in order to diversify into small-capitalization U.S. stocks. Osborne recommends the Russell 2000 Index as an appropriate small-capitalization index and recommends that Bedford Trust enter an equity swap.
Kung Chen expects the tracking stock on the Dow Jones Industrial Average (DIA) to trade within a narrow range around its current price over the near term. Based on his expectation, he believes a profitable trading opportunity is to initiate a butterfly spread strategy using call options on DIA. Osborne suggests using three one-month call options on DIA. Exhibit 3 illustrates current DIA call options expiring in one month.
Exhibit 3
DIA Call Options Expiring in One Month
Exercise Price ($)
|
Option Premium ($)
|
88
|
4.20
|
92
|
2.00
|
96
|
0.50
|
Chen wants a butterfly spread using a total of 200 long contracts and 200 short contracts.
37. If the HHM Foundation enters into the collar recommended by Osborne and the market value of QQQQ is $33 at the expiration of the options, the profit from the position would be
closestto:
A. $85,500.
B. $90,000.
C. $94,500.
If the HHM Foundation enters into the collar recommended by Osborne, the maximum potential profit from the position at expiration of the options is
closestto:
A. $145,500.
B. $150,000.
C. $154,500
At expiration of the DJX call options, the maximum potential profit from the bull spread strategy recommended for Valentine is
closestto:
A. $6,000.
B. $26,000.
C. $60,000.
The delta of Valentine’s bull spread just before contract expiration, if the price of DJX is $93, will
most likelybe in the range of:
A. 0.00 to 0.20.
B. 0.40 to 0.60.
C. 0.80 to 1.00.
If Bedford Trust adjusts its WTO exposure as Osborne recommends, it will
most likelyexperience a cash flow problem if the WTO return is positive and the index return is:
A. zero.
B. positive.
C. negative.
If Chen creates a butterfly spread using the three one-month call options suggested by Osborne, the maximum potential loss at expiration is
closestto:
A. $3,000.
B. $7,000.
C. $27,000.