Eknath, a risk averse investor is planning to take advantage of market rumour that in the upcoming budget, the Government is likely to announce some economic package including production linked incentive (PLI) scheme for

CS Executive · Securities Laws and Capital Markets · PYQS · June 2022
Eknath, a risk averse investor is planning to take advantage of market rumour that in the upcoming budget, the Government is likely to announce some economic package including production linked incentive (PLI) scheme for auto industries. As he does not like to take higher risk; he purchases one call and put option contract (Lot size 1000 shares) of a leading auto component manufacturing company at a premium of ₹5 and ₹4 respectively with strike price of ₹105. In the budget, no PLI scheme was declared and the price of stock fell to ₹90. What would be your answer, if the stock price escalates to ₹120 as Government slashed GST rate on vehicles?

Answer & Explanation:

If price of stock escalates to ₹120 The total premium paid is same as in 1st case i.e. ₹9000 The investor will now lose in put option and gain in call option. By exercising call option, Eknath will earn ₹120 - ₹105 = ₹15 per share. (lot of 1000 shares in call option). Net Profit = Profit on call - Cost/loss on premium paid on call & put option = (₹15 per share on call x 1000 shares) - ₹9000 = (₹15000 - ₹9000) = ₹6000/- In both the scenario, the net profit will remain the same.

Topics: Derivatives

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