For this part of question, we established 3M company’s option (MMM) for two weeks, which is from 8th APR 2013 to 12th APR 2013, and 15th APR 2013 to 19th APR 2013, the option is selected form the S&P 500.
The put call ratio for equity is a better determination of market sentiment as mentioned in part A, the data and distribution below shown trend of P/C Ratio. The ratio is increasing during the selected period. It started with 0.58, which is the lowest point over these two weeks. Then the ratio increased to 0.85, which is the highest point at 19th APR 2013, and the average ratio is 0.687. 0.687 is very close to 0.7, so it is generally a neutral market. According to market condition, the market is bullish when P/C Ratio near or less than 0.5, market is bearish sentiment when P/C Ratio close to 1.00. After determine the market sentiment, it may have three types of sentiment: bullish, bearish and neutral market.
Therefore, three different situations we discussed as follow.
Firstly, if the market is bullish(when P/C ratio near 0.5 or less). the Bullish strategy aim to limits potential of option fluctuating. Beneficial if one option overpriced another. A simple bullish strategy is cover call or protective put. Investors gain premium when short calls, if the stock price remains the same or rise up, the writer will be able to keep this income as profits, even profit might be higher if no call were written. The purpose of protective put is to limits possible loss from long stock. The position is go long both stock and put to hedge potential risk. Moreover, Collar strategy is also acceptable in bullish market, long a put with X1, write it on X2 to offset the cost of buying(where X1 less than X2), then holding a stock.
Secondly, if the market is bearish,(when P/C ratio close to 1 or higher than 1), the most suitable strategy is Bear spreads. The strategy set to get profit from speculation of stock price fall, but finite up or down ward potential. The position is buy a call with high excise price X2 and sell another with low excise price X1. The cost of purchases less than short the call. Same principle for arbitrage with put option. For this bearish sentiment, strategy of long put also work, but high risk because of infinity losses.
Thirdly, if the market is neutral sentiment (when P/C Ratio close to 0.7), the market will have non-directional moves in the future, strategy for this