Joseph Jones, a manager at Computer Science, Inc. (CSI), received 1,000 shares of
company stock as part of his compensation package. He did not pay for the shares. The
stock currently sells at $40 a share. Joseph would like to defer selling the stock until the
next tax year. In January, however, he will need to sell all his holdings to provide for a
down payment on his new house. Joseph is worried about the price risk involved in
keeping his shares. At current prices, he would receive $40,000 for the stock. If the
value of his stock holdings falls below $35,000, his ability to come up with the necessary
down payment would be jeopardized. On the other hand, if the stock value rises to
$45,000, he would be able to maintain a small cash reserve even after making the down
payment. Joseph considers two investment strategies:
i) Strategy A is to write January call options on the CSI shares with strike price $45.
These calls are currently selling for $3 each. (Hint: The strategy A is to buy
1,000 shares of the CSI stock and 0 cost and sell 1,000 January calls at $3 each
with strike price $45).
ii) Strategy B is to buy January put options on the CSI shares with strike price $35.
These options also sell for $3 each. (Hint: The strategy B is to buy 1,000 shares
of the CSI stock at 0 cost and buy 1,000 January puts at $3 each with strike price
Evaluate each of these strategies with respect to Joseph’s investment goals.
a) What is the cost of each strategy?
b) Write down the payoff of each strategy for all prices of the CSI stock at the
time of expiration: ST.
c) Draw the payoff of each strategy.
d) Draw the profit (net payoff) of each strategy.
e) What are the advantages and disadvantages of each strategy? Which would
you recommend? Get Finance homework help today
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