The Level III exam format

Ruth Okafor, CFA, is a private wealth adviser at Larkspur Wealth Partners. Her client, Daniel Hollis, is 61 and recently sold his engineering firm to Brennock Tools, a listed industrial company, receiving part of the price in shares. He now holds 20,000 shares of Brennock Tools, which make up a large share of his liquid wealth.

Hollis plans to sell all of the shares in three months, after the end of the current tax year, and use the proceeds to diversify. Until then he is worried about the concentration. He tells Okafor: "My main concern is a fall below $75 before I can sell. I do not want to pay any net premium for protection, and I would be content to give up any gain above $90."

Okafor gathers prices for European options on Brennock Tools that expire in three months, on the date Hollis plans to sell. Each option contract covers 100 shares.

Exhibit 1. Brennock Tools share and option prices

Current share price: $82.00

Call option, strike $85: premium $2.40 per share

Call option, strike $90: premium $1.10 per share

Put option, strike $80: premium $1.90 per share

Put option, strike $75: premium $0.80 per share

Okafor prepares three strategies, each applied to all 20,000 shares (200 option contracts for each option leg).

Exhibit 2. Strategies under review

Strategy 1: write the $85 calls (a covered call)

Strategy 2: buy the $80 puts (a protective put)

Strategy 3: buy the $75 puts and write the $90 calls (a collar)

For each strategy, Okafor measures profit at expiration as the change in value of the shares from the current price plus the option payoffs, plus premiums received and minus premiums paid. She ignores transaction costs, taxes, dividends and the time value of money. A strategy's breakeven price is the share price at expiration at which its profit is zero.

Okafor explains to Hollis that a covered call earns income but leaves most of the downside, a protective put sets a floor at a cost, and a collar trades away upside to pay for the floor. Hollis asks her to show him the numbers for each strategy and then to recommend one.

Ruth Okafor, CFA, is a private wealth adviser at Larkspur Wealth Partners. Her client, Daniel Hollis, is 61 and recently sold his engineering firm to Brennock Tools, a listed industrial company, receiving part of the price in shares. He now holds 20,000 shares of Brennock Tools, which make up a large share of his liquid wealth.

Hollis plans to sell all of the shares in three months, after the end of the current tax year, and use the proceeds to diversify. Until then he is worried about the concentration. He tells Okafor: "My main concern is a fall below $75 before I can sell. I do not want to pay any net premium for protection, and I would be content to give up any gain above $90."

Okafor gathers prices for European options on Brennock Tools that expire in three months, on the date Hollis plans to sell. Each option contract covers 100 shares.

Exhibit 1. Brennock Tools share and option prices

Current share price: $82.00

Call option, strike $85: premium $2.40 per share

Call option, strike $90: premium $1.10 per share

Put option, strike $80: premium $1.90 per share

Put option, strike $75: premium $0.80 per share

Okafor prepares three strategies, each applied to all 20,000 shares (200 option contracts for each option leg).

Exhibit 2. Strategies under review

Strategy 1: write the $85 calls (a covered call)

Strategy 2: buy the $80 puts (a protective put)

Strategy 3: buy the $75 puts and write the $90 calls (a collar)

For each strategy, Okafor measures profit at expiration as the change in value of the shares from the current price plus the option payoffs, plus premiums received and minus premiums paid. She ignores transaction costs, taxes, dividends and the time value of money. A strategy's breakeven price is the share price at expiration at which its profit is zero.

Okafor explains to Hollis that a covered call earns income but leaves most of the downside, a protective put sets a floor at a cost, and a collar trades away upside to pay for the floor. Hollis asks her to show him the numbers for each strategy and then to recommend one.

Ruth Okafor, CFA, is a private wealth adviser at Larkspur Wealth Partners. Her client, Daniel Hollis, is 61 and recently sold his engineering firm to Brennock Tools, a listed industrial company, receiving part of the price in shares. He now holds 20,000 shares of Brennock Tools, which make up a large share of his liquid wealth.

Hollis plans to sell all of the shares in three months, after the end of the current tax year, and use the proceeds to diversify. Until then he is worried about the concentration. He tells Okafor: "My main concern is a fall below $75 before I can sell. I do not want to pay any net premium for protection, and I would be content to give up any gain above $90."

Okafor gathers prices for European options on Brennock Tools that expire in three months, on the date Hollis plans to sell. Each option contract covers 100 shares.

Exhibit 1. Brennock Tools share and option prices

Current share price: $82.00

Call option, strike $85: premium $2.40 per share

Call option, strike $90: premium $1.10 per share

Put option, strike $80: premium $1.90 per share

Put option, strike $75: premium $0.80 per share

Okafor prepares three strategies, each applied to all 20,000 shares (200 option contracts for each option leg).

Exhibit 2. Strategies under review

Strategy 1: write the $85 calls (a covered call)

Strategy 2: buy the $80 puts (a protective put)

Strategy 3: buy the $75 puts and write the $90 calls (a collar)

For each strategy, Okafor measures profit at expiration as the change in value of the shares from the current price plus the option payoffs, plus premiums received and minus premiums paid. She ignores transaction costs, taxes, dividends and the time value of money. A strategy's breakeven price is the share price at expiration at which its profit is zero.

Okafor explains to Hollis that a covered call earns income but leaves most of the downside, a protective put sets a floor at a cost, and a collar trades away upside to pay for the floor. Hollis asks her to show him the numbers for each strategy and then to recommend one.

Ruth Okafor, CFA, is a private wealth adviser at Larkspur Wealth Partners. Her client, Daniel Hollis, is 61 and recently sold his engineering firm to Brennock Tools, a listed industrial company, receiving part of the price in shares. He now holds 20,000 shares of Brennock Tools, which make up a large share of his liquid wealth.

Hollis plans to sell all of the shares in three months, after the end of the current tax year, and use the proceeds to diversify. Until then he is worried about the concentration. He tells Okafor: "My main concern is a fall below $75 before I can sell. I do not want to pay any net premium for protection, and I would be content to give up any gain above $90."

Okafor gathers prices for European options on Brennock Tools that expire in three months, on the date Hollis plans to sell. Each option contract covers 100 shares.

Exhibit 1. Brennock Tools share and option prices

Current share price: $82.00

Call option, strike $85: premium $2.40 per share

Call option, strike $90: premium $1.10 per share

Put option, strike $80: premium $1.90 per share

Put option, strike $75: premium $0.80 per share

Okafor prepares three strategies, each applied to all 20,000 shares (200 option contracts for each option leg).

Exhibit 2. Strategies under review

Strategy 1: write the $85 calls (a covered call)

Strategy 2: buy the $80 puts (a protective put)

Strategy 3: buy the $75 puts and write the $90 calls (a collar)

For each strategy, Okafor measures profit at expiration as the change in value of the shares from the current price plus the option payoffs, plus premiums received and minus premiums paid. She ignores transaction costs, taxes, dividends and the time value of money. A strategy's breakeven price is the share price at expiration at which its profit is zero.

Okafor explains to Hollis that a covered call earns income but leaves most of the downside, a protective put sets a floor at a cost, and a collar trades away upside to pay for the floor. Hollis asks her to show him the numbers for each strategy and then to recommend one.