Question

Joseph Jones, a manager at Computer Science, Inc. (CSI), received 10,000 shares of company stock as part of his compensation package. The stock currently sells at $40 a share. Joseph would like to defer selling the stock until the next tax year. In January, however, he will need to sell all his holdings to provide for a down payment on his new house. Joseph is worried about the price risk involved in keeping his shares. At current prices, he would receive $400,000 for the stock. If the value of his stock holdings falls below $350,000, his ability to come up with the necessary down payment would be jeopardized. On the other hand, if the stock value rises to $450,000, he would be able to maintain a small cash reserve even after making the down payment. Joseph considers three investment strategies:
a. Strategy A is to write January call options on the CSI shares with strike price $45. These calls are currently selling for $3 each.
b. Strategy B is to buy January put options on CSI with strike price $35. These options also sell for $3 each.
c. Strategy C is to establish a zero-cost collar by writing the January calls and buying the January puts.

Evaluate each of these strategies with respect to Josephs investment goals. What are the advantages and disadvantages of each? Which would you recommend?

Answer 1

Answer:

According to strategy C would be better to adopt by jones, as this strategy allows for two ways to protect the $350000 in principal, while giving a chance to earn $450000.

strategy A must be discarded as it leaves jones to risk of extensive loss of principal.

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Explanation: