Michael Stevens Option Strategy Essay

4454 Words Apr 18th, 2012 18 Pages
Introduction Michael Stevens is a relatively new investor struggling to maintain profits in an uncertain economy. Recent conflicts and conflicting reports have left the Canadian Market muddled and somewhat divided. Michael capitalized on recent volatility in the market and has gained some unrealized profits. He sees a bullish economy returning in the near future but would like to ensure that his profits are maintained even through minor volatility for the next six months. He plans to do this through investing in options and is considering several different strategies.

1. Assessment of the Six-Month Outlook for the Market Only four years prior to Michael’s considerations, there was a significant market crash lowering the average value of
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Black-Scholes Formula Asset Price (S0/$) 16.375 Exercise Price (X/$) 17 Riskfree Rate 9% Time to Expiration (T) 128 Dividend yield 6.11% 5.48% 6.12% 4.15% Call Price (Last) $60 $90 $30 $85 Put Price (Theoretical) $104.61 $262.54 $73.29 $57.13 Implied Volatility 20.98% 31.40% 28.37% 15.13% Historical Volatility 31.7% 38.2% 23.5% 15.3%

BNS Sep 17 Calls 17.875 20 9% 184 Hess Nov 20 Calls 8.5 9 9% 93 Nova Aug 9 Calls 16.875 17 9% 184 Power Nov 17 Calls Table 1: Implied volatility of stocks in Michael’s portfolio

From Table 1, both the BNS Sep 17 Calls and Hess Nov 20 Calls appears to be undervalued as their implied volatility is lower than the stocks’ historical volatility. This means that the option price, if calculated using the historical volatility value instead, will be higher than the current market price of the options.
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Similarly, Nova Aug 9 Calls would be overvalued since its implied volatility is around 5% higher than the stock’s historical volatility. For the Power Nov 17 Calls, it appears to be fairly priced since there is only a 0.17% difference between the implied and historical volatility. With the calculated implied volatility of the four stocks in Michael’s portfolio, the corresponding prices of the put options can also be computed using the Black-Scholes model, which is shown in column 8 of Table 1.

4. Strategy of Buying Power

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