Econ 4450 Economics of Derivatives

Assignment 2

1. The price of a stock is $50. The price of a one-year European put option on the stock
with a strike price of $30 is quoted as $7 and the price of a one-year European call option
on the stock with a strike price of $50 is quoted as $5. Suppose that an investor buys 100
shares, shorts 100 call options, and buys 100 put options. Draw a diagram illustrating how
the investor’s profit or loss varies with the stock price over the next year. How does your
answer change if the investor buys 100 shares, shorts 200 call options, and buys 200 put
options?

2. A one-month European put option on a non-dividend-paying stock is currently selling

for $2.50. The stock price is $47, the strike price is $52, and the risk-free interest rate is
6% per annum. What opportunities are there for an arbitrageur?

3. A call with a strike of $60 costs $10. A put with the same strike price and expiration
date costs $5. Construct a table that shows the profit from a straddle. For what range of
stock prices would the straddle lead to a loss?

4. Three put options on a stock have the same expiration date and strike prices of $50,
$60, and $72. The market prices are $2, $8, and $18, respectively. Explain how a long
position in a butterfly spread can be created. Construct a table showing the profit from the
strategy. For what range of stock prices would the butterfly spread lead to a loss?

5. An investor believes that there will be a big jump in a stock price, but is uncertain as to
the direction. Identify four different strategies the investor can follow and explain the
differences among them.