《《Investment 8th Chap020》.doc

CHAPTER 20: OPTIONS MARKETS: INTRODUCTION PROBLEM SETS 1. Options provide numerous opportunities to modify the risk profile of a portfolio. The simplest example of an option strategy that increases risk is investing in an ‘all options’ portfolio of at the money options (as illustrated in the text). The leverage provided by options makes this strategy very risky, and potentially very profitable. An example of a risk-reducing options strategy is a protective put strategy. Here, the investor buys a put on an existing stock or portfolio, with exercise price of the put near or somewhat less than the market value of the underlying asset. This strategy protects the value of the portfolio because the minimum value of the stock-plus-put strategy is the exercise price of the put. 2. Buying a put option on an existing portfolio provides portfolio insurance, which is protection against a decline in the value of the portfolio. In the event of a decline in value, the minimum value of the put-plus-stock strategy is the exercise price of the put. As with any insurance purchased to protect the value of an asset, the tradeoff an investor faces is the cost of the put versus the protection against a decline in value. The cost of the protection is the cost of acquiring the protective put, which reduces the profit that results should the portfolio increase in value. 3. An investor who writes a call on an existing portfolio takes a covered call position. If, at expiration, the value of the portfolio exceeds the exercise price of the call, the writer of the covered call can expect the call to be exercised, so that the writer of the call must sell the portfolio at the exercise price. Alternatively, if the value of the portfolio is less than the exercise price, the writer of the call keeps both the portfolio and the premium paid by the buyer of the call. The tradeoff for the writer of the covered call is the premium income received versus forfeit of any possible capital appreciation above t