NAME:

DERIVATIVES AND FINANCIAL RISK MANAGEMENT

QUIZ-1, Spring 2004

1. Option prices on Amgen Inc are provided below. The stock closed at $ 66.25.
CALLS PUTS
Strike Mar’04 Apr’04 Mar ’04 Apr’
04
65 2.80 3.60 1.50 2.10
70 0.75 1.30 4.40 4.90

a) What would be the minimum value, the maximum value and the break-even stock
price (at expiration) for the Amgen April 65 put options?

Min value = zero

Max value = Strike price = 65 (when/if the stock goes to zero)
Break-even => 0 = 1 * [Max (0, 65- S) – 2.10], S = 62.90

b) If the risk-free interest rate until April is 1% (0.01) then use put-call parity to
check whether the April 70 options are fairly priced. If they are not, suggest what
strategy you would undertake to exploit the resulting arbitrage opportunity.

Put-call parity implies that C + PV(X) = P + S

Compare: 1.30 + [70/1.01] vs 4.90 + 66.25 OR 70.61 vs 71.15.

No the options are not fairly priced. So, short the expensive side and long the
cheaper side, i.e. Short puts and stock, buy call and T-bills