Wesfarmers shares currently trade at $43.00. A fund manager is holding a large number of Wesfarmers shares in an investment portfolio and wishes to protect the value of the investment. The manager buys a long put option with an exercise price of $42.50 per share and pays a premium of $1.30 per share.
(a) By entering into this options strategy, explain whether the fund manager will exercise the option if the spot price is above or below the exercise price.
(b) Calculate the break-even price for the long put position.
(c) Draw a fully labelled diagram of the long put and the short put positions. (LO 20.2)