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Assignment 3

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ipm01bachalas
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22 views

Assignment 3

Uploaded by

ipm01bachalas
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Assignment -3

Due date : 18th Nov, 2023


1. Call options on a stock are available with strike prices of +15, +171 2, and $20, and expiration
dates in 3 months. Their prices are $4, $2, and +1 2, respectively. Explain how the options can be
used to create a butterfly spread. Construct a table showing how profit varies with stock price for
the butterfly spread.
2. A call option with a strike price of $50 costs $2. A put option with a strike price of $45 costs $3.
Explain how a strangle can be created from these two options. What is the pattern of profits
from the strangle?
3. A call with a strike price of $60 costs $6. A put with the same strike price and expiration date
costs $4. Construct a table that shows the profit from a straddle. For what range of stock prices
would the straddle lead to a loss?
4. A trader sells a strangle by selling a 6-month European call option with a strike price of $50 for $3
and selling a 6-month European put option with a strike price of $40 for $4. For what range of
prices of the underlying asset in 6 months does the trader make a profit?
5. Three put options on a stock have the same expiration date and strike prices of $55, $60, and
$65. The market prices are $3, $5, and $8, respectively. Explain how a butterfly spread can be
created. Construct a table showing the profit from the strategy. For what range of stock prices
would the butterfly spread lead to a loss?
6. A trader creates a bear spread by selling a 6-month put option with a $25 strike price for $2.15
and buying a 6-month put option with a $29 strike price for $4.75. What is the initial investment?
What is the total payoff (excluding the initial investment) when the stock price in 6 months is (a)
$23, (b) $28, and (c) $33
7. A stock price is currently $40. It is known that at the end of 1 month it will be either $42 or $38.
The risk-free interest rate is 8% per annum with continuous compounding. What is the value of a
1-month European call option with a strike price of $39?
8. A stock price is currently $50. It is known that at the end of 6 months it will be either $45 or $55.
The risk-free interest rate is 10% per annum with continuous compounding. What is the value of
a 6-month European put option with a strike price of $50?
9. A stock price is currently $100. Over each of the next two 6-month periods it is expected to go up
by 10% or down by 10%. The risk-free interest rate is 8% per annum with continuous
compounding. What is the value of a 1-year European call option with a strike price of $100?
10. The current price of a non-dividend-paying biotech stock is $140 with a volatility of 25%.
The risk-free rate is 4%. For a 3-month time step:
(a) What is the percentage up movement?
(b) What is the percentage down movement?
(c) What is the probability of an up movement in a risk-neutral world?
(d) What is the probability of a down movement in a risk-neutral world?
Use a two-step tree to value a 6-month European call option and a 6-month European put
option. In both cases the strike price is $150
11. What does the Black–Scholes–Merton stock option pricing model assume about the probability
distribution of the stock price in one year? What does it assume about the probability
distribution of the continuously compounded rate of return on the stock during the year?
12. The volatility of a stock price is 30% per annum. What is the standard deviation of the
percentage price change in one trading day?
13. Calculate the Black-Scholes price of a 3-month European put option on a non-dividend-paying
stock with a strike price of $50 when the current stock price is $50, the risk-free interest rate is
10% per annum, and the volatility is 30% per annum.
14. A stock price is currently $40. Assume that the expected return from the stock is 15% and that its
volatility is 25%. What is the probability distribution for the rate of return (with continuous
compounding) earned over a 2-year period?
Hint: Suppose the continuously compounded return per annum between time 0 and T is x .
1 𝑆
Then, 𝑆𝑇 = 𝑆0 𝑒 𝑥𝑇 𝑎𝑛𝑑 𝑥 = 𝑇 ln ( 𝑆𝑇 )
0
15. A stock price follows geometric Brownian motion with an expected return of 16% and a
volatility of 35%. The current price is $38.
(a) What is the probability that a European call option on the stock with an exercise price of $40
and a maturity date in 6 months will be exercised?
(b) What is the probability that a European put option on the stock with the same exercise price
and maturity will be exercised
16. What is the price of a European call option on a non-dividend-paying stock when the
stock price is $52, the strike price is $50, the risk-free interest rate is 12% per annum, the
volatility is 30% per annum, and the time to maturity is 3 months?

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