You would like to be holding a protective put position on the stock of XYZ Co. to lock in a guaranteed minimum value of 250 at year-end. XYZ currently sells for 250. Over the next year, the stock price will either increase by 10% or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are traded on XYZ Co.
Required:
a. Suppose the desired put option were traded. How much would it cost to purchase?
b. What would have been the cost of the protective put portfolio?
c. What portfolio position in stock and T-bills will ensure you a payoff equal to the payoff that would be provided by a protective put with X = $100? Show that the payoff to this portfolio and the cost of establishing the portfolio matches that of the desired protective put.
Answers: 1
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