Question

1. Today is April 8^th. You own 5,000 shares of Megatronics, Incorporated (MTRN) stock. You purchased the stock 2 years ago at $119 per share and it has risen rapidly to $178 per share, far surpassing your original price target of $150. Despite slowing growth, your outlook for MTRN is still favorable. Though you believe MTRN’s upside is now limited, due to slower expected growth, it has begun paying a substantial dividend, and you believe MTRN should continue to rise, though slowly. You are, however, concerned that MTRN may fall substantially over the next month if the 1^st quarter earnings fail to meet expectations when announced on April 30. The Option Chain for MTRN is presented below.

MTRN Option Chain

	Calls			Puts
	Bid	Ask	Strike	Bid	Ask
May-19	7.75	8.05	172.5	1.82	1.91
May-19	5.50	6.25	175	2.49	2.62
May-19	4.40	4.60	177.5	3.35	3.75
May-19	3.05	3.20	180	4.50	4.70
May-19	1.92	2.16	182.5	5.95	6.25
May-19	1.23	1.41	185	7.55	7.95
June-14	8.30	10.10	172.5	2.56	3.95
June-14	6.60	8.55	175	3.20	5.00
June-14	6.00	7.15	177.5	4.40	6.10
June-14	4.65	5.60	180	4.85	6.95
June-14	3.45	4.45	182.5	6.75	8.30
June-14	1.99	3.60	185	8.15	11.95

1. What options strategy would you employ in this situation?
2. b. What Positions do you take to implement your strategy (ie., which contract(s) (long/short, calls/puts, expiration date(s), strike price(s))?
3. c. How many Contracts would you need to fully hedge your existing position? How much will it cost you to employ the strategy?

Answer 1

a) As I am long on Shares, I will use protective put strategy and buy May put options. I will not Sell call options as my view is still favourable towards the shares

b) I will long May Put option wilh Strike price of $172.5 , as I am looking for protection of value in case of substantial decrease, and with put options of strike price $172.5 I significantly lower my premium cost

c) Total no. of put options required = 5000 to hedge 5000 shares

Total cost = Ask price *5000 = $1.91 * 5000 = $9550