CHAPTER 15Uses of Options
Aims
- To show how a protective put is used to control downside risk for an individual stock or a portfolio of stocks.
- To show how ‘put–call parity’ is established by using a no-arbitrage approach.
- To demonstrate how put–call parity may be used to structure a ‘guaranteed bond’.
- To show how we can use stock index options to ‘insure’ a diversified stock portfolio against a general fall in stock prices, whilst also maintaining upside potential, should stock prices increase.
- To outline some ‘exotic options’.
15.1 PROTECTIVE PUT
15.1.1 Stock-XYZ
If you already hold stocks-XYZ then you may wish to limit any potential losses on the stocks but also be able to take advantage of any rise in the price of the stock, should this occur. Hence you want to limit the downside, but share in any upside potential. The way to do this is to continue to hold the stocks-XYZ asset but also to purchase a (European) put option on stock-XYZ, with a desired strike price and a time to maturity which matches the period you feel vulnerable to a fall in the price of stocks-XYZ. Finance Blog 15.1 sets the scene by interpreting your car insurance contract in terms of a protective put.
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