I am attaching a few other notes which I think will be relevant to this this que
ID: 2806966 • Letter: I
Question
I am attaching a few other notes which I think will be relevant to this this question.
Please please help me with this problem. So desperate.
6. Suppose that you believe that recent strong employment data ( 228,000 jobs added in November!) together with the prospect of a tax cut for corporations and wealthy families increases the likelihood that the Fed increases interest rates faster and higher in 2018 than it has previously indicated in its recent open market committee meetings. However, you don't continue to charge ahead because of increased household incomes and consumer confidence or will experience a major downturn because of investors' fears that higher know whether the bull market in equities since summer 2009 will interest rates will discourage corporate spending on physical capital and will kill the real estate rally despite corporate tax rate reductions. You notice that neither call nor put option premiums on at the money strike prices on the S&P; 500 index since the Fed's December meeting have changed noticeably from average levels for at the money premiums on the index over the last year a) Describe an options strategy that you might wish to apply that is consistent with your expectations. 4 pts What assumption are you making about the current level of implied volatility of S&P; 500 stock prices reflected in option premiums? 2pts b)Explanation / Answer
The expectation is that the Fed will increase interest rates. If interest rates increase, more money will flow in to bonds and less in to equities. So the equity market level will go down. Also, the financing cost for corporate ioncreases, which further depresses the stock markets, due to the reduced profitability of the corporates. Hence it makes sense to buy a put option on the S&P 500 since we can make money when the market goes down.
The option prices remaining unchanged shows that the estimates of volatility have not changed. So we are making the assumption that it will increase going ahead due to the Fed's interest rate decision.
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