Basic Hedging Tools

Consider contracts (call, put, forward) on 1 share of I.B.M.

Expiration date: December, 31 of current year. Forward price is $ 100.

Strike price is $ 100 for options. Cost of options is $ 10 for put and for call.
Consider a range of prices for I.B.M. on the expiration day:
$ 0, $ 20, $ 40, $ 60, $ 80, $ 100, $ 120, $ 140, $ 160 ...per share.

Do a spreadsheet and a chart for the following (a through l), you can show ‘a-f’ on one chart
and ‘g-l’ on a second chart:

Find expiration day payoff (ignore the cost of initial purchase) to a buyer of
a) 1 call, b) 1 put, c) 1 forward

Find expiration day payoff (ignore the proceeds of initial sale) to a seller of
d) 1 call, e) 1 put, f) 1 forward

Find profit and loss (including the cost of initial purchase) to a buyer of
g) 1 call, h) 1 put, i) 1 forward

Find profit and loss (including the proceeds of initial sale) to a seller of
j) 1 call, k) 1 put, l) 1 forward

Take the above charts that you printed and draw them by hand (this will clarify some of the
patterns).

Note: Contracts on foreign currencies are conceptually similar; these diagrams (or charts) will also
help you with hedging foreign exchange risk.