Hedging: example using options
Context :
Consider an investor who in May of a particular year owns 1 Microsoft shares, purchased at the current price of $28 per share.
The investor is concerned about a possible share price decline in the next 2 months and wants protection by buying a call or put option
The following 2-month options are available in the market :
Call, strike price of $24, premium of $4.5
Call, strike price of $28.5, premium of $1
Put, strike price of $25, premium of $0.2
Put, strike price of $27.5, premium of $1
Question:
A: What hedging strategy could you advise to the investor in order to hedge his risk of a possible Microsoft share price decline ? Should the investor buy a call or a put?
B: For each one of these 2 puts :
What will be the diagram of the overall net payoff?
What will be the formula for the overall net payoff?
What is the breakeven share price between these 2 options (calls or puts)
What option would you recommend?