Case Questions

Keller Case

1. To analyze the profit and loss possibilities inherent in the option investment strategies, please perform the following analyses for call and put options on Lotus’s common stock 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 profit and losses, not rates of return) at expiration (February 19, 1994) for the following investment strategies:

* Buying a call option on Lotus’s stock;

* Writing a call option on Lotus’s common stock;

* Buying a put option on Lotus’s common stock;

* Writing a put option on Lotus’s common stock.

Hint: Start by calculating the profit or loss per share assuming that, by February 19, 1994, Lotus’s common stock is selling at, say, $60 per share. Repeat this calculation for several other possible stock prices at the time of expiration that span a wide range above, below and at the exercise price of $55 per share (e.g., $45, $50, $55, $65, and so on.)

b. For each of the option investment strategies listed above, draw a graph relating possible profits and losses per share to Lotus’s stock price at the time of expiration. Put profit and losses per share on the vertical axis of your graph and stock prices on the horizontal axis.

c. Compute profits and losses per share, and graph them against stock prices for the strategy of buying a share of Lotus’s common stock at $55 per share and holding it until February 19, 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 returns 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...