Question

Options - are contracts that give the holder the right, not the obligation, to buy or sell the underlining asset at a specific price and time. How are options used to protect holdings of corporations investments? Also, how are they used for investors in corporations? Provide a real example example along with an advantage and disadvantage and your opinion of options as they pertain to an Multinational Corporation.

Answer 1

Ans: As correctly suggested,options provide the right,but not the obligation to excercise the contract i.e to buy or sell the asset at the stated price

The put option is used when the price of the asset fall below the strike price and value of asset is going down,it is purchased on belief that asset price could go below it

The call option is used when the price of the asset could rise above strike price,it allows one to buy the asset at an specific price even though market price is higher

How options are used for protecting the holdings of corporate investments

Let us take an eg.

Suppose YRF Corporation limited is having an shares trading at the current market price of 100

and suddenly a negative news float in the market about say company showing unexpected quarterly loss so the people will try to sell and price of the stock will fall

Here the company can protect the price of asset by using put options here the put option will be used that will work as the market price will hit say 80 the company will sell the shares at 80 although the market value trading say at even much lower value thus the company will recover the loss to a subsequent value

Similarly if the current market price exceeds to more than the company can execute call option and buy the shares at price of 100

There are various strategies for options such as

Long put

Long call

Short put

Covered call

Straddle,strangle and butterfly strategies

Advantage:

Company can invest in the government bonds and even the exchange traded funds as a part of investment strategy

Company can protect the asset value by keeping addressing the change in market value of stocks which is in otherwise known as hedging

The company can cover up translational risk and transactional risk when the company operates in more than one country

Disadvantage

The company can show the gains from options as speculative in nature which will not be a part of operating income which will be termed as other comprehensive income,which will project non performance of company

The company has to put large amount of money in purchasing the options which is known as the margin which will be non productive investments until the option is expected to be excercised