Prices of options on lotus stock

Assignment Help Business Management

Reference no: EM131030955

The case

The Keller All-Star Growth Fund (the Keller Fund) was a medium-sized closed-end investment company with approximately $300million invested primarily in publicly traded common stocks. Shares in the fund were owned by a large number of individual investors and were themselves listed and traded on a public stock exchange.

The Keller Fund's investment objective was to provide long-term capital appreciation. While some of its investments did yield dividends. Income was not an important consideration in its selection of stocks. Since its inception in 1985, the fund sought to achieve this objective by investing in a diversified portfolio of common stocks with above average potential for growth in revenues and earnings. High technology stocks tended to dominate its portfolio. In most years, the fund's return performance equaled or exceeded that of the Standard & Poor's composite index of 500 common stocks, though its net asset value experienced greater volatility than that of the market as a whole.

A Proposal to Initiate Option Trading Strategies

At a recent board meeting, one of the fund's trustees proposed that the board consider using put and call options as a means of enhancing the fund's performance. The fund's charter permitted it to engage in options trading, though it had not yet made use of this privilege. The trustee suggested that intelligent trading in options on a regular basis might be able to improve the fund's returns, while possibly lowering its volatility. If the board did approve the initiation of an options trading policy, the fund's charter would permit the following investment strategies:

Buying the stock of a listed company.
Buying a call option on a listed stock.
Writing (i.e., selling) a call option on a listed stock.
Buying a put option on a listed stock.
Selling a put option on a listed stock.
Various combinations of the above strategies.

Without committing the fund to pursue option trading, the board agreed that studying the concept would be in order. To prepare for their discussion at the next meeting, the trustees requested that a pilot study of the profits or losses resulting from selected option trading be conducted. As a first step, the fund officer assigned to oversee the pilot study decided to collect some information about option contracts on the common stock of AT&T Corporation and Lotus Development Corporation. These stocks were both being considered by the fund for possible purchase in the near future.

Option Prices

On Tuesday, January l8, 1994, the stock of both AT&T and Lotus closed at exactly $55 per share. Various put and Call options for each of these stocks traded on the Chicago Board Options Exchange. As shown in Exhibit1, the maturity of these options ranged from a few days to 2years in the case of AT&T options (options with maturities longer than 1year were called LEAPS). All of these contracts were so-called American options in that they could be exercised by the holder any time on or before maturity.

The quoted option prices shown in Exhibit l were in dollars per share. Each option , however, represented a contracts buy or sell 100 shares. Thus, a call option contract quoted at, say, 5 (see the Lotus April 55 call option) would actually cost $500 per contract and would give the buyer the right to purchase 100 shares of Lotus's common stock.

Background information about AT&T and Lotus is provided in Exhibits 2 and 3 respectively.

EXHIBIT 1

Selected closing Option Prices, January 18, 1994

Stock's closing price	Exercise Price	Month of maturity						Exercise Price	Month of maturity
		1994				1995 Jan	1996 Jan		1994				1995 Jan	1996 Jan
		Jan	Feb	April	July	1995 Jan	1996 Jan		Jan	Feb	April	July	1995 Jan	1996 Jan
A. Options on AT&T Corp's Stocka
Calls								Puts
55	30	25.0	--	--	--	--	--	30	--	--	--	--	--	--
55	50	5.0	--	--	6.375	7.875	10.25	50	--	--	--	--	2.0	3.25
55	55	0.5	1.375	2.3125	3.5	5.25	8.0	55	0.5	1.125	2.0625	2.75	4.375	5.5
55	60	0.0625	--	--	--	--	--	60	4.75	--	--	--	--	--
55	65	--	--	--	--	1.5	--	65	--	--	--	--	--	--
B. Option on Lotus development Corporation's Stocka
Calls								Puts
55	55	1.375	2.875	5.0				55	0.75	2.625	--
55	60	0.0625	1.75	--				60	4.0	5.5	--

a. Expiration dates are as follows: January 22, 1994; February 19, 1994; April 16, 1994; January 21, 1995; and January 20, 1996.

EXHIBIT 2

Background Information on AT & T Corp. (millions of dollars except per share data)

AT&T Corp. is the largest U.S. provider of ling-distance and cellular telephone services. It is also a major supplier of telecommunications equipment, computers, information management services, and leasing and financial services. In 1993 telecommunications provided 59% of its total revenues. AT&T's stock is listed on the New York Stock Exchange.

				Per Share
						Stock Price
Year	Revenues	Operating Income	Net Income	Earnings	Dividends	High	Low	P/E Ratio
1989	50,976	7,634	2,697	2.50	1.20	473/8	281/8	19-11
1990	51,321	7,821	2,735	2.51	1.32	465/8	29	19-12
1991	63,089	9,451	522	0.40	1.32	403/8	29	NM
1992	64,089	9,941	3,807	2.86	1.32	531/8	365/8	19-13
1993	67,156	9,864	3,974	2.94	1.32	65	501/8	22-17

EXHIBIT 3

Background Information on Lotus Development Corporation (millions of dollars except per share data)

Lotus Development Corporation is a leading developer, producer, and vendor of applications software and information services. Its major desktop applications include spreadsheet and word-processing programs, and communications products and services, including groupware and electronic mail offerings. Lotus's stock is traded over the counter on the National Association of Securities Dealers Automated Quotation (NASDAQ) system.

				Per Share
						Stock Price
Year	Revenues	Operating Income	Net Income	Earnings	Dividends	High	Low	P/E Ratio
1989	556	106	68.0	1.61	Nil	331/2	18	21-11
1990	692	147	23.3	0.54	Nil	391/4	121/2	73-23
1991	829	154	43.1	0.98	Nil	403/4	143/4	42-15
1992	900	151	80.4	1.87	Nil	383/4	143/4	21-8
1993	981	181	55.5	1.24	Nil	583/4	183/4	47-15

QUESTIONS

1. Suppose that on January 18, 1994, Lotus's stock was valued at $75.00 per share instead of $55.00. What are the very least you would expect to pay for the February 1994 call option exercisable at $55? What is the most? In general, what factors should enter into a determination of the appropriate price to pay?

2. Compare the prices of options on Lotus's stock and those on AT&T's. Why are options with identical exercise prices and maturity dates, and written on stocks with identical prices, selling for different prices? Do options on one of these two stocks provide investors with superior investment opportunities in comparison to the other?

Reference no: EM131030955

Questions Cloud

Identify the major decision making techniques models : Identify the major decision making techniques models and compare and contrast their formats. Analyze and select appropriate strategies for resolving conflict among employees.

Compute the annual approximate interest : Compute the annual approximate interest cost of not taking a discount using the following scenarios. What conclusion can be drawn from the calculations?

Write a paper about an event that started as an emergency : You are to write a paper about an event that started as an emergency and turned into a disaster. Your paper must address, at a minimum: The background of the conditions before the event began or occurred.

What is the role of smoking in the aetiology of stroke : Would you expect your client to make a complete recovery with a full return of function; explain your answer. Explain why it is important to control the existing risk factors in your client for prevention of further stroke? What is the role of smoki..

Prices of options on lotus stock : Compare the prices of options on Lotus's stock and those on AT&T's. Why are options with identical exercise prices and maturity dates, and written on stocks with identical prices, selling for different prices?

Calculate the in-plane maximum shearing strain : Discuss and define Isotropy, Anisotropy and Orthotropy with regards to engineering materials - what are the stresses relative to the x-y co-ordinate system shown?

What can the organization do to prevent this in the future : Discuss how will you proceed? What is your supervisor afraid of? What are you going to tell her is going to happen? How could this have been prevented?

How grounding is different than earthings : How grounding is different than earthings?

Neat forex transaction plan : You are required to work out a neat forex transaction plan for next one year to ensure smooth receipts and payments by the British company.

User Account

All Pages