Derivatives and Financial Markets

TOPICS: Options Prices, Effect of Dividends, and Delta Hedging

READINGS: Fundamentals of Futures and Options Markets

Chapter 13: 13.9 (Implied Volatility); 13.10 (Dividends; read only effect on European options)
Chapter 15: 15.3 (Options on stocks paying dividend yields; for question 6 below)
There is a slight adjustment to the Black/Scholes formula to account for the dividend
yield. See equations 15.4 (for calls) and 15.5 (for puts) and adjust your excel
worksheets accordingly.
Chapter 17: Section 17.4 (for questions 2 – 4 below)

ASSIGNMENT
Chapter 13:13.4, and 13.5 (dividends), 13.6, 13.15 (Implied Vol)

And
1. ABC share price is currently $100 and the volatility of stock returns is 20%. The risk-free rate is 5%
with cont. comp. What is the price and delta of a 6-month European call on ABC, with X = $100?

2. If you are long 100 of these calls, what do you expect the drop in the value of your options position to
be if the stock price drops by $1? How would you hedge against movements in ABC stock?

What would be the new call’s price and delta if ABC stock suddenly increased to $110? How should
you rebalance the hedge of the long 100 calls?

3. What is the price and delta of a 6-month European put on ABC stock with X = $100 when the stock
price is $100? If you are short 50 of these puts, how would you hedge against movements in ABC
stock price? How would you rebalance the hedge if the stock price dropped to $90?

4. Assume again ABC price is $100. What is your net delta if you were long 100 calls (6-months, X =
$100) and long 50 puts (same T and X)? How would you delta-hedge?

5. Now calculate the call and put values also at stock prices of $80, $85, $95, $105, $115, and $120. For
each of the call and put, plot the option price and intrinsic value against the 9 possible stock prices
above (ranging from $80 to $120, with $5 increments). Where does the delta of the options change the
most with the stock price, when the options are in, at, or out of the money? What is the implication for
delta hedging?

6. What happens to the call and put prices if the stock started paying 3% dividend yield? In particular,
what will the option prices be at a current stock price of $100?

Additional Exercises (can be done in a couple of minutes once question 5 is completed)

7. What happens to the call and put prices of question (5) if maturity (T) is increased to one year? Do you
notice a difference in how put prices are affected by the increase in T?
8. What happens to the call and put prices if stock return volatility increases to 40%? Is the effect of the
increase in volatility highest when the options are in, at, or out of the money?

© Walid Busaba, Ivey Business School, 2021