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assignment 5 derivatives

The document discusses various problems related to options trading, including the conditions for exercising options, profit calculations, and breakeven prices for both call and put options. It also explores the relationship between forward contracts and European options, as well as the application of put-call parity to determine option prices and implied risk-free rates. Additionally, it identifies potential arbitrage opportunities based on discrepancies between theoretical and actual option prices.

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4 views

assignment 5 derivatives

The document discusses various problems related to options trading, including the conditions for exercising options, profit calculations, and breakeven prices for both call and put options. It also explores the relationship between forward contracts and European options, as well as the application of put-call parity to determine option prices and implied risk-free rates. Additionally, it identifies potential arbitrage opportunities based on discrepancies between theoretical and actual option prices.

Uploaded by

p4q7vdpwk6
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Problem: 9.

The option allows the holder to buy a share at $100.00.


The cost of the option (premium) is $5.00.
The option will be exercised if the stock price at maturity (S_T) is greater than $100.00, since
buying at $100 would be profitable.
The profit is calculated as:
Profit = max (ST - 100, 0) - 5
The breakeven price occurs when:
ST - 100 - 5 = 0 → ST = 105
The option holder makes a profit when S_T > 105.
Problem: 9.10

The option allows the holder to sell a share for $60.


The cost of the option (premium) is $8.
The option will be exercised if the stock price at maturity (S_T) is less than $60, since selling at
$60 would be profitable.
The seller (short position) profits when the option is not exercised or when the loss is less than
the premium received.
The profit for the short position is:
Profit = 8 - max(60 - S_T, 0)
The breakeven price occurs when:
8 - (60 - S_T) = 0 → S_T = 52
The seller makes a profit when S_T > 52.
Problem 9.11
This problem requires analyzing a portfolio consisting of:
- A long forward contract on an asset.
- A long European put option with the same strike price and maturity as the forward contract.

Our goal is to determine the terminal value of this portfolio and show that it is equivalent to a
European call option with the same strike price and maturity.

A long forward contract obligates the holder to buy the asset at the forward price (F₀) at maturity.
Its payoff at expiration is given by:

Payoff = Sₜ - F₀

A European put option provides the right (but not the obligation) to sell the asset at the strike
price (F₀). The payoff at expiration is:

Payoff = max(F₀ - Sₜ, 0)

The total payoff of the portfolio is the sum of both payoffs:

Total Payoff = (Sₜ - F₀) + max(F₀ - Sₜ, 0)

Since max(F₀ - Sₜ, 0) ensures that the payoff is zero when Sₜ > F₀, the final expression simplifies
to:

Total Payoff = max(Sₜ - F₀, 0)

This is exactly the payoff of a European call option with strike price F₀ and the same maturity.
Problem 9.20
Options on General Motors stock follow the March, June, September, and December expiration
cycle. On the specified dates, the available contracts are:
-March 1: Contracts expiring in March, June, September, and December.
- June 30: Contracts expiring in June, September, December, and March of the following year.
- August 5: Contracts expiring in September, December, March, and June of the following year.

Problem 10.14:
To determine the price of the European put option, we use the put-call parity formula:

C - P = S₀ - K e^(-rT) + PV(Dividends)

Where:
- Call price (C) = $2
- Put price (P, unknown)
- Stock price (S₀) = $29
- Strike price (K) = $30
- Risk-free rate (r) = 10%
- Time to expiration (T) = 6 months = 0.5 years
- PV(Dividends) = Present value of two $0.50 dividends

Solving for P, we find:

P = $0.57
Problem 10.24
Using put-call parity, we solve for the implied risk-free rate (r). The formula is:

C - P = S₀ - K e^(-rT)

Given:
- Call price (C) = $20
- Put price (P) = $5
- Stock price (S₀) = $130
- Strike price (K) = $120
- Time to maturity (T) = 1 year

Solving for r, we find:

r = 4.26% per annum

Problem 10.25
We analyze whether an arbitrage opportunity exists using put-call parity.

Given:
- Call price (C) = $3
- Put price (P) = $3
- Strike price (K) = $20
- Stock price (S₀) = $19
- Dividend = $1 (expected in one month)
- Risk-free rate (r) = 10% per annum
- Time to expiration (T) = 3 months

Using put-call parity, we compute the theoretical call price:

Theoretical Call Price = $1.50

Since the actual market call price is $3, which is higher than the theoretical price, an arbitrage
strategy can be implemented by shorting the overpriced call option and hedging accordingly.

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