You simultaneously write a covered put and buy a protective call, both with stri

ID: 2694664 • Letter: Y

Question

You simultaneously write a covered put and buy a protective call, both with strike prices of $110, on stock that you have shorted at $110. What are the expiration date payoffs to this position for stock prices of $100, $105, $110, $115, and $120? (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.) Stock price Short Profit Covered Put Payoff Protective Call Payoff Total Payoff $ 100 $ $ $ $ $ 105 $ $ $ $ $ 110 $ $ $ $ $ 115 $ $ $ $ $ 120 $ $ $ $

Explanation / Answer

Generally, investors buy common stocks for two reasons. Many stocks offer a cash dividend, and they also have the potential to provide a capital gain. In this publication, we will present a method for calculating stock prices based on a constant growth model, leveraging a discounted cash flows approach which considers both dividends and capital gains.

In this example:

Expected Return, or R = ($3.00 + $5.00) / $100.00 = 8.0%

We can now use this expected return to calculate the price of a stock in the same risk class as Stock A using the following formula:

Stock Price = (Dividends Paid (Div) + Expected Price (P1)) / (1 + Expected Return (R))

Proving this calculation with our example information above, we have:

Stock Price = ($3.00 + $105) / (1 + 0.08) = $108.00 / 1.08 = $100

Some individuals may recognize this stock price calculation as the beginnings of a discounted cash flow formula. Essentially, the price of a stock is the cash flows gained by the stockholder, divided by the discount rate or market capitalization rate.

price of sale ratio

P/S= (stock price) / (sales per share) = (market capitalization) / (total sales)

price of book share

P/B = (stock price) / (book value per share) = (market capitalization) / (total shareholder equity)

price to cash flow ratio

P/CF = (stock price) / (operating cash flow per share)

dividend yield
Dividend Yield = (per share dividend)/ (stock price)

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You simultaneously write a covered put and buy a protective call, both with stri

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