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    Tutorial Solutions Week 11

    Uploaded by

    Jaden Eu
    The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

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    Tutorial Solutions Week 11

    Uploaded by

    Jaden Eu
    28 views3 pages
    The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

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    Tutorial solutions week 11

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    The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    28 views3 pages

    Tutorial Solutions Week 11

    Uploaded by

    Jaden Eu
    The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
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    Tutorial solutions week 11

    Question 1.
    “Once we know how to value options on a stock paying a dividend yield, we know how to value
    options on stock indices, currencies, and futures.” Explain this statement.

    Answer
     A stock index is analogous to a stock paying a continuous dividend yield, the dividend
    yield being the dividend yield on the index.
     A currency is analogous to a stock paying a continuous dividend yield, the dividend yield
    being the foreign risk-free interest rate.
     A futures is analogous to a stock paying a continuous dividend yield, the dividend yield
    being the risk-free interest rate.

    Question 2.
    How does the put–call parity formula for index/currency/futures options differ from put–call
    parity for an option on a non-dividend-paying stock?

    Answer
    The put–call parity formula for index/currency/futures options is the same as the put–call parity
    formula for non-dividend-paying stock options except

     The stock price is replaced by S0e-qT in the case of index options


     The stock price is replaced by S0e-rfT in the case of currency options
     The stock price is replaced by F0e-rT in the case of futures options

    Question 3.
    What are advantages of futures options over spot options?

    Answer
     Futures contract may be easier to trade than underlying asset
     Exercise of the option does not lead to delivery of the underlying asset
     Futures options and futures usually trade in adjacent pits at exchange – not so relevant
    now with electronic trading
     Futures options may entail lower transactions costs
    Question 4.
    Calculate the value of a three-month at-the-money European call option on a stock index when
    the index is at 250, the risk-free interest rate is 10% per annum, the volatility of the index is 18%
    per annum, and the dividend yield on the index is 3% per annum. What is the value of the
    corresponding put option?

    Answer
    S0  250 , K  250 , r  010 ,   018 , T  025 , q  003 and

    ln(250  250)  (010  003  0182  2)025


    d1   02394
    018 025
    d 2  d1  018 025  01494
    N(d1 ) = N(0.2394) = N(0.23) + 0.94 ∗ [N(0.24) − N(0.23)] = 0.5910 + 0.94 ∗ [0.5948 − 0.5910]
    = 0.5946
    N(d2 ) = N(0.1494) = N(0.14) + 0.94 ∗ [N(0.15) − N(0.14)] = 0.5557 + 0.94 ∗ [0.5596 − 0.5557]
    = 0.5594
    The call price is
    c= 250*0.5946*e-0.03*0.25-250*0.5594* e-0.10*0.25=11.14
    The put price is
    p= c + Ke-rT- Se-qT=11.14+ 250* e-0.10*0.25-250*e-0.03*0.25=6.84

    Question 5.
    Calculate the value of an eight-month European put option on a currency with a strike price of
    0.50. The current exchange rate is 0.52, the volatility of the exchange rate is 12%, the domestic
    risk-free interest rate is 4% per annum, and the foreign risk-free interest rate is 8% per annum.
    What is the value of the corresponding call option?

    Answer
    S0  052 , K  050 , r  004 , rf  008 ,   012 , T  06667

    ln(052  050)  (004  008  0122  2)06667


    d1   01771
    012 06667
    d 2  d1  012 06667  00791

    N(d1 ) = N(0.1771) = N(0.17) + 0.71 ∗ [N(0.18) − N(0.17)] = 0.5675 + 0.71 ∗ [0.5714 − 0.5675]
    = 0.5703
    N(d2 ) = N(0.0791) = N(0.07) + 0.91 ∗ [N(0.08) − N(0.07)] = 0.5279 + 0.91 ∗ [0.5319 − 0.5279]
    = 0.5315
    N(−d1 )=1- N(d1 )=1-0.5703=0.4297
    N(−d2 )=1- N(d2 )=1-0.5315=0.4685
    The put price is
    p = 0.50*0.4685*e-0.04*0.6667-0.52*0.4297*e-0.08*0.6667=0.0162
    The call price is
    c= p + Se-qT -Ke-rT= 0.0162+0.52*e-0.08*0.6667 - 0.50*e-0.04*0.6667=0.0223

    Problem 6.
    An index currently stands at 1,500. European call and put options with a strike price of 1,400
    and time to maturity of six months have market prices of 154.00 and 34.25, respectively. The six-
    month risk-free rate is 5%.What is the dividend yield?

    Answer
    c + Ke-rT = p + S0 e-qT
    154  1400e00505  3425  1500e05q
     1500e-0.5q = 154+1400e-0.05*0.5-34.25 = 1485.18
     -0.5q = ln(1485.18/1500)= -0.0099
     q = -0.0099/(-0.5)= 0.0198 = 1.98%
    Question 7.
    An index currently stands at 696 and has a volatility of 30% per annum. The risk free rate of
    interest is 7% per annum and the index provides a dividend yield of 4% per annum. Calculate
    the value of a three month European put with an exercise price of 700. What is the value of a
    three month European call also with an exercise price of 700?

    Answer
    S0 = 696, K=700, r=0.07, σ=0.3, T=0.25, q=0.04
    696 0.32
    ln (700) + (0.07 − 0.04 + 2 ) 0.25
    𝑑1 = = 0.0868
    0.3√0.25
    𝑑2 = 𝑑1 − 0.3√0.25 = −0.0632
    N(-𝑑1 ) = 0.4654
    N(-𝑑2 ) = 0.5252
    The put price is
    p=700*0.5252*e-0.07*0.25-696*0.4654*e-0.04*0.25=40.60
    The call price is
    c= p + Se-qT -Ke-rT=40.60+696*e-0.04*0.25-700*e-0.07*0.25=41.82

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