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# Q 8.

25
The price of a stock is \$40. The price of a one-year European put option on the stock
with a strike price of \$30 is quoted as \$7 and the price of a one-year European call
option on the stock with a strike price of \$50 is quoted as \$5. Suppose that an investor
buys 100 shares, shorts 100 call options, and buys 100 put options. Draw a diagram
illustrating how the investor’s profit or loss varies with the stock price over the next year.
i. Draw a diagram illustrating how the investor’s profit or loss varies with the stock
price over the next year.
Initial outlay = -\$4,000 + \$500 - \$700 = -\$4,200
If an investor buys 100 shares, shorts 100 call options, and buys 100 put options:
Profit (\$)

\$500

Long 100 shares

Short 100 call options

Stock Price
\$30

-\$700

\$40

\$50

Long 100 put options

\$1. How does your answer change if the investor buys 100 shares. and buys 200 put options: Profit (\$) Long 100 shares \$1000 Short 200 call options Stock Price \$30 -\$1400 Stock Price Payoff from long put \$40 \$50 Long 200 put options Payoff from short Payoff from Total Profit .Stock Price range S<30 30≤S<40 40≤S<50 S≥50 Payoff from long Payoff from short put options call options 30-ST 0 0 0 0 0 0 50-ST Payoff from long shares ST-40 ST-40 ST-40 ST-40 Total Payoff -10 ST-40 ST-40 15 Profit -52 ST-82 ST-82 -32 When ST>50.400 If an investor buys 100 shares. the long 100 put options will cover the loss of long 100 shares. shorts 200 call options. and buys 200 put options? Initial outlay = -\$4.400 = -\$4. shorts 200 call options. ii.000 + \$1000 . the loss of the short 100 call options will be covered by the profit of long 100 shares and when ST<30.

Question 9. the loss of the short 100 call options will be covered by the long 100 shares which leaves the remaining short 100 call options naked and this will result in greater loss.range S<30 30≤S<40 40≤S<50 S≥50 options 30-ST 0 0 0 call options 0 0 0 50-ST long shares ST-40 ST-40 ST-40 ST-40 Payoff -10 ST-40 ST-40 15 -52 ST-82 ST-82 -32 When ST>50.22 . the loss of the long 100 shares will be covered by the long 100 put options which leaves the remaining long 100 put options naked and this will result in greater profit. When ST<30.

1 * 0.16 = 18.4641 1.50 Put option undervalued by \$1.0833 Dividend received NP at month 6 PV of net profit Q 11.1*0.00) 18.50 .Call Parity C + Xe-rt = p + So – D 3 + 20e -0. Premium paid = \$3 Buy the stock ( price paid =\$19) Sell the call option (premium received = \$3) Borrow \$19 a.5354 1.1*0.4557 = 1.51 > \$21.01 Difference = \$1.Put. Borrow \$1 for 1 month 3 month later Sale of stock (fixed at \$20) Repayment of loan: 18e0.50 Today 1) 2) 3) 4) Buy the put option (undervalued). Borrow \$18 for 3 month b.25 1e 0.0084 (1.25 = 3+19-1e 0.1*0.0833 \$22.

0) = 12 fd = max(S-X.0 A .1212 [0.125 = \$45 C \$50 x 0. Verify that no-arbitrage arguments and risk-neutral valuation arguments give the same answer. It is known at the end of six months it will either be \$60 or \$42.6162(12) + 0. The risk-free rate of interest with continuous compounding is 12% per annum.0) = max(60-48.A stock price is currently \$50.12 6 e rT  d 12  0.2 \$50 d= \$42 = 0.12 C \$42Δ . Calculate the value of a six-month European call option on the stock with an exercise price of \$48.3838 Node B Stock Price \$50 x 1.84 \$50 0.96 Verifying no-arbitrage arguments & risk-neutral valuation The riskless portfolio is: Long: Δ shares Short: 1 call option \$50 B \$60Δ . Risk-neutral valuation: u= \$60 = 1. Given X= \$48. 0) =0 f = e  rT [pfu + (1-p)fd] 6 = e  0.875 = \$42 A \$50 Option Value fu = max(S-X.84 1 – p = 1 – 0.6162 p= = e ud 1.2  0.0) = max(42-48.3838(0)] = 6.6162 = 0.84 = 0.

The portfolio is riskless when: 60Δ – 12 = 42Δ 18Δ = 12 Δ = 0.96 Thus. 6 The value of the portfolio today is: 28 e  0. which are 6.1212 = 26.96. the value of the portfolio The value of portfolio is 0.37 The value of the stock today = \$50 Option price denoted = f The value of the portfolio today is: 50 x 0. Question 13.6667 shares Short: 1 call option The value of the portfolio in 6 months is: 60Δ – 12 = 60(0.6667) – 12 = 28 Given r = 12%.6667 despite of whether stock price moves up to \$60 or down to \$42 Long: 0.20 .6667.6667 – f = 26.37 f = 6. the risk-neutral valuation and no-arbitrage arguments give the same answer.

75 r=0.09)0.4508 N(D1) = 0.75 K=0.09*0.75 [0.0053+0.3386 N(D2) = 0.75/2] / 0.75*e(0.75) + 0.75 = 0.75 Volatility= 0.07*0.75e-0.04*√0.09 T=0.7169-0.866 = -0.07-0.7388 D1 = [ln(0.0159 Calculation of VaR .7388/0.04²*0.75 = -0.So=0.3386 – 0.75 p=0.3261] C= 0.07 rf=0.4162 D2 = 0.4162-0.7388*0.3261 C=e-0.9347 p=0.04 Value of Call Option Fo = 0.0053 Put Call Parity 0.75 = p + 0.04*0.07*0.75e-0.75*0.

96*6000 = 11.992 The 10-day 97.000×0.55 Silver: one day 97.000×0.Standard deviation of the change in the portfolio value per day is therefore (5400) 2  (6000) 2  2 * 0.5% VaR is therefore: 10200*1.584 10-day 97.220.437.012=\$6.5% VaR = 10584* 10 = 33.437. .992= 63.469.5% VaR is 10 * 19.5% VaR = 1.Standard deviation of the change in value of the investment in gold per day is \$300.69 Therefore.39 Portfolio: 10-day 97.220.25=7.220.5% VaR = 11.220.69.400 .5% certain that we will not lose more than \$ 63.5% VaR is 10 * 19.25 Benefits of Diversifications Gold: one day 97. we are 97.188.6 * 5400 * 6000 = 10.5% VaR = 1.25 Thus.469.760* 10 = 37.96*5400=10.Standard deviation of the change in value of the investment in silver per day is \$500. (33.992= 63..188.760 10-day 97.63.018=\$5.39).96=19.55+37.25497 in the next 10 days and the reduction through diversification is \$ 7.200 Thus one day 97.000 .