Risk Management Case Solution
Binomial Option Pricing and a Simple Hedge with Options
- It is quit challenging to agreed that on the accurate pricing of any tradable assets, the reason is stock price is continuously is keep changing. In reality company is hardly to changes on day-to-day basis. The stock price and its valuation change every second, it shows that it is very difficult to reach at the present day price of any tradable asset.
On 1st march 2016, Investor is thinking that he is bearing too much risk and expecting that in future the price of the stocks will decrease so he decided to hedge their position by entering in put option. The put option is an option gives the owner right to sell their shares, at a specified amount with the specified time. Currently stock price of BHP is $16.30, and the strike price of the put option is $16. A put option will become more valuable when the price of stock depreciate more than the strike price. So if the stock price decreased more than 16 in the next four months, the investor will exercise the option, because the has a right to sell the option. Each put option covers the single share; as the investor’s portfolio worth is $10,002.7 and the stock price is $16.3, so that investor has to buy 624 put options, in order to hedge their risk.
- profit from option holding
The investor will exercise the option only when the price of stock will be lower than the strike price in next four months. As the strike price is 16. When the investor is buying the put option he has to pay premium, According to the case value of the put option is 15.
- The investor want to hedge his portfolio rounded to nearest 100 shares. When the investor decided to hedge that means he is insuring themselves against a negative event, as the investor not able to eliminate the entire negative event but he tried to reduce the impact of negative event by hedging. The portfolio managers reduce their risk by using huge techniques. Hedging against investment risk means investor strategically using in the market to offset the risk of any adverse price movement. There are many techniques available which investors can used in order to hedge their position. sell the covered call, buy put option and replace stock with options
The investor will buy the put option when he thinks that price of the share in future will decreased. The investor will exercise the put option when the price of the share is lower than the strike price at the time of maturity. He will not exercised the put option when the price of the share is higher than the strike price at the time of maturity that indicate that investors can sell their shares in the market at higher price than the strike price. The one advantage of the put option is to limit the loss...............
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