Derivatives I

Assignment 1

Winter 2015/16

1. Contracts
The chemical company Oil ABC needs 1 million barrels of oil to support its production in one
year. Assume that the oil price is 70$ per barrel today. Analysts expect the oil price to either
increase to 100$ per barrel or to decrease to 60$ per barrel during the next year.

(a) Which derivative products (discussed in the lecture) could the company use to hedge the
oil price risk? Please first define and then explain the instruments.
(b) Assume that the company decides to hedge with forward contracts. What will be its payoff
in one year if the forward price equals 70$ per barrel?
(c) Assume that the company decides to hedge with options. Assume that the price of a call
on one barrel of oil equals 2.5610$ today. What will be its payoff in one year if it acquires
call options maturing in one year with a strike price of 70$? What does it cost to enter
the option contract?

2. Option Strategies
Assume that you purchase a call option with strike price K1 and sell a call option with strike
price K2 , where K1 < K2 . The two options have the same time to maturity.

(a) Draw the payoff diagram of the option position at maturity. How is this option strategy
called?
(b) Assume that the stock price equals K1 today. Under which circumstances is this option
position a suitable strategy?
(c) Show that the call price is decreasing in the strike price K.
(d) Assume that only put options are traded in the market. How can you achieve the same
payoff structure? Solve this problem graphically as well as computationally.

3. Discount Certificate

(a) Draw the payoff diagram for a discount certificate.

(b) What is the objective of an investor purchasing a discount certificate?
(c) Describe two alternative strategies that give you the same payoff profile.

4. Time Value, Put-Call-Parity

Prove that the time value of a European call equals the time value of a European put with
identical strike price and time to maturity. To do so assume that the underlying does not pay
any dividends and that the intrinsic value is calculated based on the discounted strike price.