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FOD Assignment-Ayush Goyal

This document contains the answers to questions about options and derivatives submitted by a student. [1] It explains the key differences between hedging, speculation, and arbitrage using examples. [2] It computes the future price of an index using given interest rates and formulas. [3] It compares features of future and forward contracts. [4] It constructs a butterfly spread strategy and identifies the price range that would lead to gains.

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kartikay Gulani
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47 views

FOD Assignment-Ayush Goyal

This document contains the answers to questions about options and derivatives submitted by a student. [1] It explains the key differences between hedging, speculation, and arbitrage using examples. [2] It computes the future price of an index using given interest rates and formulas. [3] It compares features of future and forward contracts. [4] It constructs a butterfly spread strategy and identifies the price range that would lead to gains.

Uploaded by

kartikay Gulani
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Future, Options & Derivatives Assignment

Submitted by:

Ayush Goyal

PGP21035

Ques. 1 (a)

Explain the difference between hedging, speculation and arbitrage with the help of suitable examples.

Ans:

Basis Hedging Speculation Arbitrage


Meaning It involves offsetting Short term Buying & Simultaneously buying
position (opposite long selling strategies. & selling of an asset for
& short options) to profit.
balance profits/gains.
Main motive To reduce risk Make profit from price Make profits due to
changes market inefficiency.

Ques. 1 (b)

Compute a three month future price of S& P Nifty if the Index provides a yield of 2% per annum,
the current price is 10800 and risk free interest rate is 8% per annum with continuous compounding.

Ans:

Future price=
F0  S0 e( r q )T

F= (10800) * e^ [(0.08-0.02)*(.25)]

F= (10800)* e^ [0.015]

F= 10800*1.0151

F=10963.08
Ques. 2 (a)

Explain the difference between a future and forward contract?

Ans:

Basis Future contract Forward contract


Meaning It is an agreement traded through It is an agreement to buy or sell an
an exchange. asset at a certain future time for
(Publically traded) certain price.

Control Exchange specifies certain There are no such standards fixed


standardized features for contract, for forward contracts. These are
as both parties are unknown. not regulated by any market.
Risk Low counter party risk High counter party risk
Maturity Maturity depends on both the Mature after delivery of
parties. commodity.

(b) The stock price of XZ Ltd. is trading at 380. Compute the lowest price of a three month European put
option of XZ Ltd. stock if the risk-free interest rate is 9%, strike price of stock contract is 400.

Ans:

{Strike price*e^(r-k)}- Stock price

{400* e^ [(0-0.09)*(.25)]} - 380

{400* e^ (-0.0225)} – 380

{400*0.9777} – 380

391.08-380

1.08

Ques.3 (a)
Three call options on Nifty with same expiration of 23rd April, 2020 with strike prices of 8600,
8800, and 9000 are given as Rs. 300, 175 and 90 respectively. Construct a butterfly spread and
show for what range of nifty index prices would the butterfly spread lead to gains only?

Ans:

Strike price Call


8600 300
8800 175
9000 90
Buy 1 call at 90 & 1 at 300 = (390)

Sell 2 calls at 175= 175*2=350

Maximum loss= 40

Maximum profit=200-40=160

160

8760 8960

40

(b) A European put option on Tata Steel stock at the strike price of Rs.440 with expiry of three
months is Rs. 30 with risk-free interest rate of 7% per annum and the current price of stock is Rs.
435. Identify the arbitrage opportunities open to trader if the put price is Rs. 40 or 20.

Ans:
i.
So=440, r= 0.07 , c=30 , k=435, p=40

St>=435 0 40 gain
435-440
St<= 440 -5 45 loss
max

ii.
So=440, r= 0.07 , c=30 , k=435, p=20

St>=435 0 20 gain
435-440
St<= 440 -5 15 loss

Ques4 (a)

What is a straddle strategy? Under what conditions does this strategy lead to maximum gain to
an Investor?

Ans:

A straddle is a trading strategy that involves options. To use a straddle, a trader buys/sells a


Call option and a Put option simultaneously for the same underlying asset at a certain point of
time provided both options have the same expiry date and same strike price.

A trader will profit from a long straddle when the price of the security rises or falls from the
strike price by an amount more than the total cost of the premium paid. Profit potential is
virtually unlimited, so long as the price of the underlying security moves very sharply.

(b) Bank nifty index is trading at 20500 in the spot market and 3-month Bank nifty future
contract is trading at 20800. Compute the arbitrage opportunities if the Index provides a yield of
2.5% per quarter and risk free interest rate is 7% per annum with continuous compounding.
Ans:

F= S+ Interest- Dividend

F=20500+ (20500*0.07*0.25) – (20500*0.0025)

F=20346

Theoretically, future price should be priced at Rs.20346 but given is Rs. 20800. So it is
overpriced.

Arbitrage profit= 20800-20346 =454

Ques. 5 (a) Explain protective put trading strategy.

Ans:

A protective put is a risk-management strategy using options contracts that investors employ to
guard against the loss of owning a stock or asset. The hedging strategy involves an investor
buying a put option for a fee, called a premium.

(b) A stock currently trades at 800 (face value Rs.5). The risk free interest rate is 10% per annum
with continuous compounding and dividend paid by the company is 20%, 10% and 15% at the
end of second, third and fourth month respectively. Compute the future price of the mid-month
contract?

Ans:

2nd month 3rd month 4th month


Dividend 0.20*5=1 0.10*5=0.5 0.15*5=0.75
Present value (1/(e^rt) 0.983 0.487 0.725

Total= 0.983+0.487+0.725=2.22

Future price= Stock price* e^ rt

F= (800-2.22)* e ^ (0.07*.025)

F=950.40

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