Dartmouth College, Fall 2017

Mathematical Finance I, Math 86 S. Nanda

Assignment 6 Due: Nov 8, 2017

You may discuss the problems and solutions with anyone but the work written up and
submitted must be done on your own. Justify every step. Draw pictures where it helps
to illustrate. Please write legibly.

Balck Scholes solution of a european call is:

VC (S, t) = SN (d1 ) − Ke−r(T −t) N (d2 ), (1)

2/2)(T −t) 2
/2)(T −t)
where d1 = ln(S/K)+(r+σ
√
σ T −t
and d2 = ln(S/K)+(r−σ
√
σ T −t
. Now that we have the closed
form solution for derivatives’ prices for a Black Scholes model we can try to interpret the
solution and get some insight.

1. What is the probability that a European call will expire in-the-money?

2. Using the solution of the Black-scholes model for a european call option, calculate the
following greeks:

(a) Gamma, Γc : The second derivative with respect to spot price

(b) Vega, νc : The derivative with respect to the volatility.
(c) Theta, Θc : The derivative with respect to time
(d) Rho, ρc The derivative with respect to the interest rate r

3. Implement ∆ and Γ in excel and test them. That is let  be a small number and compute
the price change for bumping the parameter by  and divide by . For example, for
delta calculate Vc (S+,T )−Vc (S,T ) , keeping other parameters T, σ, r, d fixed. This is
basically a finite difference scheme.
Write down your finite difference formula for ∆ and Γ in your submitted homework.
Once you have all the formulas working and tested, plot the following graphs and
interpret them:

(a) Delta of a call option as a function of spot

(b) The Delta of a call option as a function of time for in-the-money, out-of-the money
and at-the money options
(c) The Gamma of a call option as a function of spot

You can do the above using spot prices for your favorite stock. This way you can
compare your call prices with quoted call prices too. Or you can construct an example,
and choose parameter values appropriately. Take your expiration time for call to be 6
months.
 Compare the Delta you calculate here with your binomial model in excel using the 10
time steps that you had constructed. Comment on any differences you find. Submit
your code along with your written solution.

4. ( Some practicalities). We are in the Black-Scholes world with the following: S = 100,
Volatility = 0.10, r = 0.05 and d = 0. We find from our computations that that two
options have the characteristics given in the table below. What amounts of stock and
option B would you hold to hedge a short position in option A if:

(a) Delta Hedging

(b) Delta and Gamma hedging
(c) Delta and Vega hedging

Option A B
pay-off call call
Maturity 1 2
Strike 100 110
Price 6.805 2.174
Delta 0.709 0.343
Gamma 0.034 0.037
0 Vega 34.294 36.781