MGMT 476 Homework #3: Chapter 7: Options Markets

1. (Question’s 2 and 3 in text) Explain the following terms in the context of options
a. long
b. short
c. call
d. put
e. American
f. European
g. Bermuda
h. in-the-money
i. out-of-the-money
j. at-the-money
k. strike
l. holder
m. buyer
n. writer
o. seller
p. expiry
q. premium
r. over-the-counter
s. exchange-traded

2. (Question 6 in text) What is the difference between over-the-counter (OTC) contracts and
exchange-traded contracts?

3. (Question 10 in text)
What position in naked options would you adopt if you believe that the price of the
stock is going to drop and the volatility of the stock is going to decrease?
4. (Question 13 in text.) Draw a gross payoff diagram for a short position in a call at strike
100. Also draw the gross payoff diagram for a long position in a put option at the same
strike and maturity as the call. Overlay these plots on the same axis to get an aggregate
payoff diagram for the portfolio of call and put. What other security do you know of with
the same payoff diagram as this portfolio? Be sure to include a title, axis titles, and a
legend (handwritten is fine, but you can also use excel if you want, make it clear which
series is for long and short positions).

5. (Question 20 in text) Employee stock options have additional risk over and above
standard call options in that the employee may not be able (or allowed) to cash in the
option in the event of termination of the employee’s job with the firm if the option is not
vested. But if the option is vested, and immediate exercise in the event of termination is
possible, should it be worth as much as a standard American option on the firm’s stock
price? Explain.