These trading rules include relative strength buy if

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Unformatted text preview: Portfolio Management Semester 1, 2011 To compute a payoff table: 1. 2. 3. 4. Identify the composition and initial payoff of the position Define a range of hypothetical final stock prices S* Compute the final payoff off the position Deduct the initial payoff from the final payoff to arrive at the P/L position A break even occurs when the P/L = 0. Summary for a long stock: Payoff moves in the same direction as the final stock price Investors adopt the position in anticipation of rising prices as the position results in a profit at any final stock price above the breakeven point The long stock has unlimited upside profit potential The potential loss is limited to the cost of buying the share, which occurs when the price falls to zero. S HORT A STOCK To short a stock means selling a stock we do not own, thus the initial stock must be borrowed. Initial Payoff = -S0 Final Payoff = -S* Profit and Loss = S0 - S* Summary for a short stock: Payoff moves in the opposite direction to the final stock price Investors adopt the position in anticipation of falling prices as the position results in a profit at any final stock price below the breakeven point The short stock has limited profit, as maximum profit occurs when S* turns to 0. The downside risk is unlimited and gets worse as S* increases in value. L ONG A CALL When we buy an option, we acquire its intrinsic value and time values, which change over time. When the option expires, it has no time value and we are left with its intrinsic value determined solely by the stock price. Initial Payoff = C0 Final Payoff = Max {S* – X, 0} Profit and Loss = Max {S* – X, 0} - C0 Summary for a long call: Payoff moves in the same direction to the final stock price if the option finishes in the money, and becomes 0 if the option finishes at or out of the money Investors adopt the position in anticipation of rising prices as the position results in a profit at any final stock price above the breakeven point The long call has unlimited upside profit potential, an increasing funct...
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This document was uploaded on 03/21/2014.

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