The market received some information about ABC Ltd.'s tie up with a Multinational Company. This has induced the market price to move up. If the…

CA Final · Advanced Financial Management · PYQS · May 2024
The market received some information about ABC Ltd.'s tie up with a Multinational Company. This has induced the market price to move up. If the information is false, the ABC Ltd.'s stock price will probably fall dramatically. To protect from this, an investor has bought the call and put options. He purchased one 3 month's call with a striking price of 45for 3premium and paid 2 per share premium for a 3 month's put with a striking price of 42. Assume 100 shares for call and put option. You are required: (i) To determine the investor's position if the tie up offer bids the price of ABC Ltd.'s stock up to 44 in 3 months. (ii) To determine the investor's position of the tie up offer program fails and the price of the stocks falls to 34 in 3 months. (iii) To determine the investor's position if the tie up offer program is successful and the price of the stocks rise up to 46 in 3 months.

Suggested Answer and Working Notes:

Total premium paid on purchasing a call and put option = (3per share × 100) + (2per share × 100). = 300 +200 = 500 (i) In this case, investor exercises neither the call option nor the put option as both will result in a loss for him. Ending value = -500 + zero gain = 500 i.e. Net loss = 500 (ii) Since the price of the stock is below the exercise price of the call, the call will not be exercised. Only put is valuable and is exercised. Total premium paid = 500 Ending value = 500 + ₹ [(42 – 34) × 100] = -500 +800 = 300 i.e. Net gain = 300 (iii) In this situation, the put is worthless, since the price of the stock exceeds the put's exercise price. Only call option is valuable and is exercised. Total premium paid = 500 Ending value = -500 + [(46 – 45) × 100] = -500 + 100 = -400 i.e. Net Loss = 400

Topics: Derivatives Analysis & Valuation

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