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FNCE 326: Options, Futures, and Other Derivatives

This document contains four multi-part problems related to options pricing and derivatives strategies. The first problem involves calculating the maximum profit, maximum loss, and breakeven stock price for a bull call spread using two call options. The second problem requires identifying the strategy created by buying a put and call with the same strike price and calculating breakeven stock prices. The third problem involves hedging a short call position, calculating the risk-neutral probability of an up move, and pricing a call option using no-arbitrage and risk-neutral valuation. The fourth problem involves pricing an American put option on a stock using a two-step binomial tree.

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Rashid Jalal
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59 views6 pages

FNCE 326: Options, Futures, and Other Derivatives

This document contains four multi-part problems related to options pricing and derivatives strategies. The first problem involves calculating the maximum profit, maximum loss, and breakeven stock price for a bull call spread using two call options. The second problem requires identifying the strategy created by buying a put and call with the same strike price and calculating breakeven stock prices. The third problem involves hedging a short call position, calculating the risk-neutral probability of an up move, and pricing a call option using no-arbitrage and risk-neutral valuation. The fourth problem involves pricing an American put option on a stock using a two-step binomial tree.

Uploaded by

Rashid Jalal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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FNCE 326: Options, Futures, and Other Derivatives

There are a total of four multi-part problems with point values shown; please show all
work and be clear about your solutions and final answers.
1. Three-month call options with strike prices of $30 and $40 cost $7 and $4,
respectively. Please answer the following in three numbered steps and explain
what happens for each step: (25 Pts Total)
a. What is the maximum profit per unit when a bull spread is created from
the calls? (9 Pts)
1.

2.

3.
b. What is the maximum loss per unit when a bull spread is created from the
calls? (8 Pts)
1.

2.

3.
c. At what terminal stock price, ST, does strategy produce a zero profit per
unit when a bull spread is created from the calls? (8 Pts)
1.

2.

3.
2. Consider an investor who buys a Put for $4 with a strike price of $60 and buys a
Call for $7 with a strike price of $60. Please answer the following: (15 Pts Total)
a. What kind of Strategy has the investor created and what does the investor
hope the stock will do? (5 Pts)

b. Show by two numbered, 3-step examples at what two terminal stock prices
the investors profit will equal exactly $0. Be sure to indicate in your
examples what happens to each option and calculate the profit. (10 Pts)

3. Consider a six-month European Call option on a non-dividend paying stock with a


strike price of $30. The current stock price is $26 and over the next six months it
is expected to rise to $44 or fall to $12. The continuously compounded risk-free
rate is 5%. Please answer the following: (30 Pts Total)
a. Draw a properly-labeled, neat one-step binomial tree. (3 Pts)

b. What position in the stock is necessary to hedge a short position in 1 Call


option? Show by means of a calculation. (5 Pts)

c. What is the risk-neutral probability of the stock rising to $44? (5 Pts)

d. What is the value of the Call option under no-arbitrage valuation and riskneutral valuation? (17 Pts)
No-Arbitrage Valuation:

Risk-Neutral Valuation:

4. Consider an American Put option on a non-dividend paying stock where the stock
price is $20, the strike price is $30, the risk-free rate is 6% per annum with
continuous compounding, the volatility is 20% per annum, and the time to
maturity is 6-months. Calculate the price of the American Put option using a twostep binomial tree of equal time length. (30 Pts Total)
Calculate: u, d, and p for the two-step tree: (7 Pts)

Draw the Properly-labeled Tree with proper stock prices (leave unknown values
of f as a ?): (8 Pts)

Calculate the Price of the option (Please label your calculations by Node): (15
Pts)

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