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  • Chapter One. Options: Butterfly Spread

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    The document summarizes solutions to exercises from a book on financial option valuation. Exercise 1.1 describes the payoff of holding two call options with strike prices E1 and E3 and writing two call options with strike price E2. The value at expiry is the payoff of the long calls minus twice the payoff of the short calls. Exercise 1.3 illustrates the payoff diagram of a butterfly spread option strategy, which reaches a maximum payoff of 1 when the stock price equals E2.

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    The document summarizes solutions to exercises from a book on financial option valuation. Exercise 1.1 describes the payoff of holding two call options with strike prices E1 and E3 and writing two call options with strike price E2. The value at expiry is the payoff of the long calls minus twice the payoff of the short calls. Exercise 1.3 illustrates the payoff diagram of a butterfly spread option strategy, which reaches a maximum payoff of 1 when the stock price equals E2.

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    14 views1 page

    Chapter One. Options: Butterfly Spread

    Uploaded by

    ltravanca
    The document summarizes solutions to exercises from a book on financial option valuation. Exercise 1.1 describes the payoff of holding two call options with strike prices E1 and E3 and writing two call options with strike price E2. The value at expiry is the payoff of the long calls minus twice the payoff of the short calls. Exercise 1.3 illustrates the payoff diagram of a butterfly spread option strategy, which reaches a maximum payoff of 1 when the stock price equals E2.

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    Chapter One.

    Options
    Outline Solutions to odd-numbered exercises from the book: An Introduction to Financial Option Valuation: Mathematics, Stochastics and Computation, by Desmond J. Higham, Cambridge University Press, 2004 ISBN 0521 83884 3 (hardback) ISBN 0521 54757 1 (paperback) This document is c D.J. Higham, 2004 1.1 Rise Fall Fall Rise 1.3 Holding the two call options contributes max(S E1 , 0)+max(S E3 , 0) and writing the two call options contributes 2 max(S E2 , 0). Hence, value at expiry date is max(S E1 , 0) + max(S E3 , 0) 2 max(S E2 , 0). (1)

    Payo diagram is shown below. Note the payo curve has maximum value 1 of E4 := 2 (E3 E1 ) at S = E2 .
    Butterfly Spread
    E_4

    Payoff

    0 0

    E_1

    E_2

    E_3

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