Myles Houck holds 800 share of Lubbock Gas and Light. He thought the stock sever
ID: 2755121 • Letter: M
Question
Myles Houck holds 800 share of Lubbock Gas and Light. He thought the stock several years ago at 47.78 dollars, and the shares are now trading at 75.50 dollars. Myles is concerned that the market is beginning to soften. He doesn't want to sell the stock, but he would like to be protect the profit he's made. He decides to hedge his position by buying 8 puts on Lubbock G&L; The 3-month puts carry a strike price of 75.50 dollars and are currently trading at 2.64 dollars. How much profit or loss will Myles make on this deal if the price of Lubbocl:G&L; does indeed drop, to 61.00 dollars a share, by the expiration date on the puts? How would he do if the stock kept going up in price and reached 92.00 dollars a share by the expiration date? What do you see as the major advantages of using puts as hegde vehicles? Would Myles have been better off using in-the money puts-that is put with an 88.50 dollars strike price that are trading at 10.58 dollars? How about using out-of the money puts-say, those with a a71.00 dollars strike price, trading at 1.10 dollars? Explain. If the price of Lubbock G&L; does indeed drop, to 61.00 dollars a share, by the expiration date on the puts, Myles will have a profit(or loss) of SExplanation / Answer
a) Myles will have a profit of 75.5 - 61 = $14.5 * 2.64 = $38.28
b) Myles would not have to excercise the put as the market vale of share is over the hedge value i.e $92
But if he excercise put then he will be at a loss of (92 - 75.5) *2.64 = $43.56
c) The major advantages of usin put as a hedge vehicle
d) If he buys put of strike rate $85.5 trading at $10.58, he will make profit of atleast $10*10.58 now $105.8
but if the price of the share increase above $85.5 then he will make losses.
If he uses out of put at $71, the profits would be low but so will be the losses.
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