Covered call option writing and protective put option buying are recognized by the investment community for hedging a long stock position. Suppose a money manager holds 100 shares of D-S-9 Corporation at a current price of $100 and presently not paying a dividend and not anticipated to do so over the next year. The total value of the portfolio is $10,000. A European call option on 100 shares of D-S-9 with a $100 strike price that expires in 3 months can be sold for $700 (call price per share, c, times 100 shares). Alternatively, a 3-month European put option can be purchased for $500 (the put price per share, p, times 100 shares). The risk-free rate, r, is expected to be 8.16 percent over the life of these options.
Analyze the profit and loss position of the portfolio for the alternative strategies of writing a call or buying a put at the common expiration date:
1. Are the options mispriced according to the theoretical put-call relationship for all prices of the call at expiration?
a. Price of D-S-9 is $107 or $112 at expiration?
b. Price of D-S-9 is $100 at expiration?
c. Price of D-S-9 is $102 at expiration?
d. Price of D-S-9 at expiration?