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Practice Question 1

This document contains 7 questions related to options pricing and hedging. Question 0 involves calculating the value of European and American put options given stock price movements and interest rates. Question 1 asks about the difference between using forward contracts and options for hedging. The remaining questions involve calculating option values, break-even points, and profits/losses given stock price movements and scenarios involving buying stock vs options.

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90 views

Practice Question 1

This document contains 7 questions related to options pricing and hedging. Question 0 involves calculating the value of European and American put options given stock price movements and interest rates. Question 1 asks about the difference between using forward contracts and options for hedging. The remaining questions involve calculating option values, break-even points, and profits/losses given stock price movements and scenarios involving buying stock vs options.

Uploaded by

Nguyễn Quỳnh Hương
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Question 0: A stock price is currently $40.

Over each of the next two 3-month periods it is expected to


go up by 10% or down by 10%. The risk-free interest rate is 12% per annum with continuous
compounding. (a) What is the value of a 6-month European put option with a strike price of $42? (b)
What is the value of a 6-month American put option with a strike price of $42?

Question 1: What is a fundamental difference between the use of forward contracts and options for
hedging?

Question 2: On 03 March 2006, Comverse Technology (symbol: CMVT), currently trading at $25.30, has
been hit by an options accounting scandal. The stock has begun to reverse into a downtrend.

You believe that the stock could drop by 20% to $21 in the next 3 months. You decide to purchase one
contract of CMVT July 25 Puts (slightly ‘out of the money’). From the Option Chain on your online
broker’s site, you find that the July 25 Puts are trading at $0.90. From this information, calculate the
following:

1. How much would it cost to buy one contract?

My initial investment is ______________________

2. What is your breakeven point?

(i.e. Strike Price – Option Premium)

My breakeven point is ______________________

3. If CMVT drops to $23 in 3 months, what is the minimum profit you

will make? (i.e. Strike Price – Stock Price – Option Premium)

4. Draw the Risk-Return Graph

Question 3: When first issued, a stock provides funds for a company. Is the same true of a stock option?
Discuss.

Question 4: On May 8, 2013, as indicated in Table 1.2, the spot offer price of Google stock is $871.37
and the offer price of a call option with a strike price of $880 and a maturity date of September is
$41.60. A trader is considering two alternatives: buy 100 shares of the stock and buy 100 September call
options. For each alternative, what is (a) the upfront cost, (b) the total gain if the stock price in
September is $950, and (c) the total loss if the stock price in September is $800. Assume that the option
is not exercised before September and if the stock is purchased it is sold in September.

Question 5: 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?

Question 6: A stock price is currently $50. Over each of the next two 3-month periods it is expected to
go up by 6% or down by 5%. The risk-free interest rate is 5% per annum with continuous compounding.
What is the value of a 6-month European call option with a strike price of $51?

Question 7: ‘‘Options and futures are zero-sum games.’’ What do you think is meant by this?

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