Case: The Keller Funds Option Investment Strategies
1. To analyze the loss and profit possibilities inherent in the options investment strategies, please perform the following analyses for call and put options on Lotus's common stocks that mature in February, 1994 and that have an exercise price of $55 per share.
a. compute net profits and losses per share (actual dollar profits and losses, not rates of return) at expiration (February 1994) for the following investment strategies
- buying a call on Lotus's stocks
- Writing a call option on Lotus's common stocks.
- buying a put option on Lotus's common stocks
- writing a put option on Lotus's common stocks.
b. for each of the option investment strategies listed above, draw a graph relating possible profits and losses per share the Lotus's share price at the time of expiration. Put profits and losses per share on the vertical axis of your graph and stock price on the horizontal axis.
c. Compute profits and losses per share, and graph them against stock price for the strategy of buying a share of Lotus's common stock at price of $55 and hold it until February 1994.
2. Study the graph created in your answer to question 1, which of the various strategies examined offers the greatest upside return? The least upside return? The greatest downside potential? The least downside potential? Which is likely to produce better investment return more often? In your opinion, which strategy is the most aggressive? Which is the most conservative? In general, are investment strategies involving options risky or safe?
3. If you owned Lotus's stock, but were concerned about the possibility of bad news. How might you use options to protect yourself against the risk of a price decline?
4. Buy a share of Lotus's stock at $55 per share while simultaneously writing (selling) a call option with an exercise price of $55 per share is called a "covered call" (also a buy-write) investment strategy. What is the relationship between covered call positions and selling put options? Do the quoted put and call option prices appear to be consistent with this relationship?
5. Suppose that on January 18, 1994, Lotus's stock was valued at $75 per share instead of $55. What is the very least you would expect to pay for the February 1994 call option exercisable at $55? What is the most? In general, what factors should enter into the determinants of the appropriate price to pay?
6. Compare the option price on Lotus's and those on AT&Ts. Why are options identical with exercise prices and maturity dates, and written on stocks with identical prices, selling for different prices? Do options on one of those stocks provide investors with superior investment opportunities in comparison to the others?
7. In general, what "play" would you make on AT&T or Lotus's stock in January 1994?