Mundell Flaming

PRACTICE Problems

Problem : There is a rumour that Dr Reddy’s Laboratories  Ltd is to going to place its case for Patents in US Law Courts , the stock of Co. starts moving up, however things are expected to reverse for Co if it fails to win the case. Mr A a BMS Student wants to profit from this situation. Determine whether he shall succeed if he buys a 1 month call at  Rs. 17 premium and also buys a 1 months put at Rs 11 premium; both the options have a uniform strike price of Rs 1050 (Market Price on date of transaction is also Rs 1050). Also assume the price of Mahindra’s stock after 3 months is (a) Rs 1100(b) Rs 977 . Ignore transaction costs, but consider premium. Given Mr A buys 100 shares each of call and put option.

Solution : Cost of 2 options : 17 x 100 + 11 x 100 = 2800.

1. When the final price is Rs.1300 : Gain from Strategy(Call)  = 50 x 100 = 5000, Cost = 2800 ( from above), net gain = 2200
2. When the price falls to Rs 977 Gain from strategy (put) = 73 x100 = 7300 , cost = 2800 Gain = 4500

Problem

A : 1000 shares of a stock are purchased @ Rs 80 per share = Rs 80,000. Build a portfolio so that the investor is able to limit the risk which must not be more than 15 % in any situation You are also given additional information  Put Option @ Rs.75 & Call Option @ 90 per share (ignoring premium)

Sol : Suppose along with this stock the investors buys 1000 puts and sells 1000 calls let us see if the portfolio is immunized

If the market price falls 30 per share then his investment in stock becomes 30,000 (loss of 50000) & he can go in for put which is available at 75 which gives a benefit of 45000 ,keeping the net loss position to 5000 (< 15 %) , on the other hand if the market rises price to 200, stock gives a benefit of 1,20,000 ,but being a seller of call , he loses 110 i.e. 110000, net benefit again is 10000 (<15 %)

Problem : Determine the profit of Sanjeev when he has established the following spread on stock of Tata Chemicals Co. Ltd.   (1) Bought a three month call having exercise price as Rs 68 , premium paid Rs 4 (2)  Bought  a six month call having exercise price as Rs 69 , premium as Rs 5 per share. The stock of Tata Chem  is currently selling at Rs.58.  What shall be the profit or loss if the price of  the stock after three months is Rs 65 & after six months  Rs 73

Solution :

As we can see the spread falls under (a) category