What portfolio position in stock and T-Bills will ensure you a payoff equal to the payoff that would be provided by a protective put with X = $50?
A) ½ share of stock and $25 in bills
B) 1 share of stock and $50 in bills
C) ½ share of stock and $26.19 in bills
D) 1 share of stock and $25 in bills

Question

Quizplus · Accepted Answer

In order to replicate the payoff of a protective put with X=$50, we need a portfolio position that will provide us with a minimum payoff of $50 if the stock price falls below $50. One way to achieve this is to have a long position in 0.5 shares of stock and a short position in 0.5 puts with X=$50. The cash generated from the short put can be invested in risk-free T-Bills to earn a return. Calculations show that with the current stock price and risk-free interest rate, $26.19 in T-Bills is sufficient to provide a total payoff of $50 in case the stock price falls below $50. So the correct answer is C.

What Portfolio Position in Stock and T-Bills Will Ensure You