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QUESTION

Ford, at a recent conference call, said that its contract with the United Auto Workers prevents it from shutting down a Louisville factory.

Ford, at a recent conference call, said that its contract with the United Auto Workers prevents it from shutting down a Louisville factory. However, it did announce that it is moving its small cars production from Michigan to Mexico. Unfortunately, any threats to the current free trade agreements that the US has with Mexico will likely have a large effect on companies like Ford. Ford stock (NYSE: F) has 18.6% over the last year. The following table shows options data for contracts expiring a month from now: Calls for December 23, 2016 Strike Last Price Bid Ask Volume Open Interest Delta Gamma 11 0.9 0.88 1.05 4 6 0.775 0.237 11.5 0.49 0.52 0.58 3 289 0.632 0.298 12 0.25 0.23 0.26 135 604 0.476 0.315 12.5 0.08 0.08 0.09 14 2360 0.329 0.286 13 0.07 0 0.06 1 310 0.209 0.227 Puts for December 23, 2016 Strike Last Price Bid Ask Volume Open Interest Delta Gamma 10 0.1 0.04 0.1 5 5 -0.050 0.081 10.5 0.03 0.01 0.07 13 50 -0.117 0.155 11 0.1 0.1 0.12 33 401 -0.225 0.237 11.5 0.19 0.15 0.19 50 376 -0.368 0.298 12 0.45 0.43 0.5 87 169 -0.524 0.315 12.5 0.7 0.67 0.78 7 290 -0.671 0.286 13 1.25 1.05 1.33 11 0 -0.791 0.227 19 7 6.25 7.55 3 0 -0.934 0.102

a. The current stock price is 11.85 (as of 11:30 am today). You expect that the stock will drop further and want to take advantage of this expectation by trading in options. What position in option contracts will you take? You can buy any contract from the table that fits with your belief.

b. Each contract involves 100 shares of the underlying stock. Suppose your position involves the purchase of 10 contracts. What is your initial cost?

c. What is the Delta and Gamma of your portfolio?

d. Use the previous answer to estimate the change in your portfolio value if Ford’s price drops by $0.50.

e. How would you make your portfolio Delta neutral?

f. Suppose Ford’s price at the expiration of the option contract next month is 11.10. What is the payoff on your option contract?

g. Are option contracts an example of a linear or nonlinear product? Why?

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