P1.T3.136 PQ set # 136.4 Pgs 15 - 16 - Ch1 Reading 12 - Hull

[Dr. Jayanthi Sankaran]

Hi David,

136.4 Consider three positions on the same underling asset: 1. Long forward (forward price
at current spot price), 2. Short forward (forward price at current spot price) and 3. Short put
option (strike price at current spot price). Which sequence, from lowest potential to
highest, describes their MAXIMUM PROFIT potential?

a) Long forward < short forward < short put
b) Short forward < short put < long forward
c) Short put < long forward < short forward
d) Short put < short forward < long forward

136.4 D. Short put, short forward, long forward
short put: premium received is maximum gain (must be a % of spot price since FMV strike).
short forward: forward price is maximum possible gain
long forward: unlimited maximum possible gain

For the above, what does FMV stand for? Is it 'Future Market Value' but then what does it mean in the context of the strike?

Please help me understand
Thanks!
Jayanthi

 

[David Harper CFA FRM]

Hi @Jayanthi Sankaran it refers to "fair market value" in that context but it's not helpful, sorry! When I worked with options (which was a lot, I did a lot of ESO consuliting), we called options with a strike set at the current spot (stock) price as "FMV options," versus premium options (i.e., strike > spot) or discount (i.e., strike < spot). In that way, as the put is "strike price at current spot price," I reverted to shorthand FMV to mean the same thing. But I don't think it helps, sorry. Thanks!

 

[Dr. Jayanthi Sankaran]

Hi David,

Yes, it makes perfect sense....I guess ESO stands for Employee stock options?

Thanks!
Jayanthi

 

[David Harper CFA FRM]

HI @Jayanthi Sankaran Yes, ESO is employee stock options (sometimes might mean Executive Stock Options, too, I suppose)