Question

George Soros and Warren Buffet both believe the stock market is going down (i.e. stock prices will fall). Buffet decides to use an option strategy and Soros decides to use a forwards strategy. Currently, the stock market is priced at $200. A call option has a strike of $205 and costs $2. A put option has a strike of $195 and costs $3. The forward price is $201. Each investor uses the respective derivative strategy mentioned above. What is the profit/loss of each investor if the market finishes at $198?

Multiple Choice

• Soros breaks even

  Buffet profits $1

• Soros profits $3

  Buffet loses $2

• Buffet loses $3

  Soros profits $3

• Soros loses $2

  Buffet profits $1

• Soros profits $2

  Buffet profits $3

Answer 1

Soros and Warren Buffet both feel that the stock market is going to fall.

Buffet decides to go for an option strategy while Soros will go for a forward strategy.

Since Buffet wants to bet on the stock market falling he will buy a Put option at a strike price of $195 and at a premium of $3. This means that if the stock market falls below $195 the option will get exercised otherwise the option will lapse.

Since market finishes at $198, the put option will Lapse.The only cost to Warren Buffet will be the premium of $3.

Exercise Price	Stock Price	Put(Exercise/Lapse)	Payoff	Premium	Net Profit/(Loss)
195	198	Lapse	0	(3)	(3)

On the other hand Soros also expects markets to fall.Hence he will sell a forward at $201. That means that if stock market falls below $201, he will gain.

The stock market finishes at $198

Hence gain to Soros =$201-$198 = $3.

So the correct answer is as follows:

• Buffet loses $3

  Soros profits $3