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  • Question 5: Derivatives and Portfolio Management (33 Points)

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    jacch123
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    The document describes a portfolio involving options on a stock market index. a) The portfolio involves writing two calls with a strike of 1000 and buying one call each with strikes of 900 and 1100, resulting in no net premium paid or received. b) For dynamic hedging, the trader would need to initially sell futures to hedge the position. As the index rises, the futures position would need to be gradually reduced and eventually switched to buying futures. c) To obtain the same payoff as the options portfolio in part a), the trader would buy puts with strikes of 900 and 1100 and write puts with a strike of 1000.

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    CIIA

    Original Title

    Derivatives in Portfolio Management Q5 March 2005

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    The document describes a portfolio involving options on a stock market index. a) The portfolio involves writing two calls with a strike of 1000 and buying one call each with strikes of 900 and 1100, resulting in no net premium paid or received. b) For dynamic hedging, the trader would need to initially sell futures to hedge the position. As the index rises, the futures position would need to be gradually reduced and eventually switched to buying futures. c) To obtain the same payoff as the options portfolio in part a), the trader would buy puts with strikes of 900 and 1100 and write puts with a strike of 1000.

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    © All Rights Reserved
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    3 views2 pages

    Question 5: Derivatives and Portfolio Management (33 Points)

    Uploaded by

    jacch123
    The document describes a portfolio involving options on a stock market index. a) The portfolio involves writing two calls with a strike of 1000 and buying one call each with strikes of 900 and 1100, resulting in no net premium paid or received. b) For dynamic hedging, the trader would need to initially sell futures to hedge the position. As the index rises, the futures position would need to be gradually reduced and eventually switched to buying futures. c) To obtain the same payoff as the options portfolio in part a), the trader would buy puts with strikes of 900 and 1100 and write puts with a strike of 1000.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    of 2

    Question 5: Derivatives and Portfolio Management

    (33 points)

    Consider futures and European options on the stock market index (SMI) of a given
    country. The stock index is currently at 1000, and 3-month futures as well as 3-month
    options on this Index with strike prices of 900, 1000 and 1100 are trading at exactly
    their theoretical price. There are no dividends, and trading costs and margin costs can be
    ignored.
    a) You write 2 calls with strike prices of 1000 and purchase 2 calls, one with a strike
    price of 900 and the other with a strike price of 1,100.

    Call price

    a1) In total, will you pay or receive the premium on this trade? Explain your answer
    with reference to the chart below that shows the relation between call premiums
    and strike prices.
    (5 points)

    0
    90 1,000
    100 1,100
    110
    900

    Strike price

    a2) Draw a graph that illustrates the payoff at expiration for this position.

    (5 points)

    a3) What kind of expectation of the stock market performance (in terms of returns and
    volatility) and preference for profit and loss, would a portfolio manager have
    when taking this position?
    (4 points)
    b) Assume that a trader has just bought the strategy described in a) and that he wants to
    use futures to implement dynamic hedging.
    b1) Explain whether this trader needs to sell or buy futures or not trade at all at the
    current point in time.
    (4 points)
    b2) Discuss whether and/or how the answer to b1) would change if the SMI index
    rises gradually from 1,000 to 1,200. Explain what adjustments would be needed in
    the futures position at different values of SMI between 1000 to 1200.
    (4 points)
    c) You want to use puts to obtain the same payoff at expiration as in a). Describe the put
    option trading you would do, including strike prices.
    (6 points)

    d) Briefly discuss how portfolio managers should determine whether to hedge their
    portfolios by using either futures contracts or option contracts.
    (5 points)

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