What would have been the cost of a protective put portfolio?
You would like to hold a protective put position on the stock of Avalon Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon currently sells for $50. Over the next year, the stock price will increase by 10% or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are traded on Avalon Co.
A. $48.81
B. $51.19
C. $52.38
D. $53.38
B. $51.19
The hedge ratio is -.5. A portfolio comprising one share and two puts would provide a guaranteed payoff of 55,
with present value of 55/1.05 = 52.38. Therefore,
S + 2P = 52.38
50 + 2P =
52.38 P = 1.19
The protective put strategy = 1 share + 1 put = 50 + 1.19 = 51.19
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