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Homework #4 - Lectures 8 and 9: Option Pricing in Continuous Time, BSM Model, Greeks

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13 views5 pages

Homework #4 - Lectures 8 and 9: Option Pricing in Continuous Time, BSM Model, Greeks

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svenka12
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© © All Rights Reserved
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Homework #4 - Lectures 8 and 9: Option

pricing in continuous time, BSM model,


Greeks
FE-620
Due date 11 November 2024

Problem 4.1
Assume that the stock price St follows the geometric Brownian motion pro-
cess
dSt
(1) = µdt + σdzt .
St
where zt is a Wiener process (standard Brownian motion).
What is the process followed by:

(a) y = 3S

(b) y = S 3

(c) y = sin(zt )

(d) y = Ser(T −t)

Note: This is to get practice applying Itô’s lemma. Quant job/internship


interviews often contain such a problem.

1
Problem 4.2 (Evaluating the Black-Scholes formula)
Consider an European option on a non-dividend-paying stock. Currently the
stock price is $50, the option exercise price is $51, the risk-free interest rate
is 5.0%, the volatility is 45% per annum, and the time to maturity of the
option is 6 months.
Using the Black-Scholes European option price formula, evaluate the price
of this option, assuming that:
(a) it is an European call option
(b) it is an European put option
(c) Verify that put-call parity holds

2
Problem 4.3(variation on 15.28 in Hull)
The closing prices of the Tesla stock for the month of February 2022 are given
in the table below.
Estimate the annualized stock price volatility. What is the standard error
of your estimate?

> head(price,30)
TSLA.Close
2022-02-01 931.25
2022-02-02 905.66
2022-02-03 891.14
2022-02-04 923.32
2022-02-07 907.34
2022-02-08 922.00
2022-02-09 932.00
2022-02-10 904.55
2022-02-11 860.00
2022-02-14 875.76
2022-02-15 922.43
2022-02-16 923.39
2022-02-17 876.35
2022-02-18 856.98
2022-02-22 821.53
2022-02-23 764.04
2022-02-24 800.77
2022-02-25 809.87
2022-02-28 870.43

3
Problem 4.4(Variation on 19.26 in Hull)
Consider a 1-year European call option on a stock when the stock price is
$30, the strike price is $30, the risk-free rate is 5.0%, and the volatility is
25% per annum. Compute the price, delta, gamma and vega of the option
under the Black-Scholes-Merton model.
i) Verify that delta is correct by changing the stock price to $30.1 and
recomputing the option price.
ii) Verify that gamma is correct by recomputing the delta for the situation
where the stock price is $30.1.

4
Problem 4.5 (Delta hedging an option position)
A trader sells an European call option on TSLA stock on 1-Feb-2022, with
maturity 28-Feb-2022, with strike $870.00 for a premium of $81.54. Use the
TSLA stock prices from Problem 4.3.
The trader assumes an implied volatility σ = 45%, and zero risk-free rate
r = 0. Use the time to maturity 19 days, or T = 19/252 years.
The trader would like to Delta hedge the option dynamically, setting it
up at inception (1-Feb-2022) and updating the hedge every day.
1) How many shares are needed on 1-Feb-2022 to Delta hedge the option?
Is the position in stock long or short?
2) How many shares are in the Delta hedge at maturity on 28-Feb-2022?

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