Question 1

Organisation of Markets & Contracts

Why do you think the most actively traded options tend to be the ones that are near the money?
Question 2
Pricing of Contracts
The common stock of the firm has been trading in a narrow range around $50 per share for
months, and you believe it is going to stay in that range for the next 3 months. The price of a
3-month put option with an exercise price of $50 is $4

a. What is the no-arbitrage price of a call with X=$50? Assume no dividends and rf = 10%

b. What would be a simple options strategy using a put and a call to exploit your conviction
about the stock price’s future movement? What is the most money you can make on this
position? How far can the stock price move in either direction before you lose money?

c. How can you create a position involving a put, a call, and riskless lending that would have the
same payoff structure as the stock at expiration? What is the net cost of establishing that
position now?
Question 3
Option Strategies

• Which strategy is best given the objective?

– Performance to date: +16%
– Objective: earn at least +15%
– Scenario: High volatility

• Choices:
A. Long straddle
B. Long bullish spread
C. Short straddle

• Which strategy is best given the objective?

– Performance to date: +16%
– Objective: earn at least +15%
– Scenario: Large chance of losses

• Choices:
A. Long puts
B. Short calls
C. Long calls
Question 4
Option Strategies
• Graph the pay-off pattern of a butterfly spread; which involves a combination of the following
positions:
– Long call at X1
– Two short calls at X2
– Long call at X3
With the same expiration date, and the difference between X1 and X2 equal to that between X2
and X3. Map the pay-offs.

• A vertical combination involves a combination of the following positions (again, produce a

graph of the pay-off pattern):
– Long put at X1
– Long call at X2
Question 5
Option Strategies
The manager received 10,000 shares of company stock as part of his compensation package.
The stock currently sells at $40 a share. He would like to defer selling the stock until the next tax
year. In January, however, he will need to sell all his holdings to provide for a down payment on
his new house. He is worried about the price risk involved in keeping his shares. At current
prices, he would receive $400,000 for the stock. If the value of his stock holdings falls below
$350,000, his ability to come up with the necessary down payment would be jeopardized. On
the other hand, if the stock value rises to $450,000, he would be able to maintain a small cash
reserve even after making the down payment.

He considers three investment strategies:

a. Strategy A is to write January call options on the CSI shares with strike price $45. These calls
are currently selling for $3 each.
b. Strategy B is to buy January put options on CSI with strike price $35. These options also sell
for $3 each.
c. Strategy C is to establish a zero-cost collar by writing the January calls and buying the
January puts.

Evaluate each of these strategies with respect to the manager’s investment goals. What are the
advantages and disadvantages of each? Which would you recommend?
Question 6
Option Strategies
We see a put (X=60) traded for $2, and on another exchange that same amount will buy you a
put with strike 62. How do we make a profit by holding the position till maturity?
Question 7
Option Strategies
Joe just purchased a stock index fund for $2400 per share. He also purchased an at-the-money
European put for $120 with strike price $2400. Sally says that Joe could better have bought a
cheaper put with strike price $2340 (out-of-the- money), which sells at $90

a. Analyze Joe’s and Sally’s strategies by drawing profit diagrams

b. When does Sally’s strategy do better?
c. Which strategy entails greater systemic risk?
Question 8
Option Strategies
Compare two strategies: investing in the index, currently at 1350, and adding a protective put
with strike 1170 (put costs $9); on the other hand you might buy calls (X=1260) for $180 and
T-bills with 1260 as face value cost $1,215.
a. Draw the payoffs of both strategies in 1 figure.
b. Which portfolio must require a greater initial outlay to establish?
c. Make a table of the profits realized for each portfolio for the following values of the stock price
in 3 months: ST= $1,000, $1,260, $1,350, $1,440.
d. Which strategy is riskier?
e. Why is put-call parity not violated?
Question 9
Option Strategies
We’re looking into a strangle strategy (owning both puts and calls with different strikes) due to
expected movement coming from a court decision. Do we need to be long or short? What are
the maximum profits, losses and when do we break even?
- Current stock price is $58
Question 10
You need to check the difference between gold on the spot market (where it trades for $1150.00
an ounce) and futures with a 6-month maturity. Physical gold has a 2% a year storage cost.
Assume the interest rate is 0.5%. You may assume discrete interest rates, and that one future
contract represents one ounce. Margin payments are 10%.

Now we have a 12- month futures trading at $1175.00, and a 12-month put option with strike
price $ 1200.00. The put is worth $240. Assume we have a portfolio consisting of 100 ounces of
physical gold, a short position of 50 futures and are long 20 put options.

(parts a. and b. done last week)

c. Determine the pay-offs, profits and returns of investing in this portfolio (assuming it's kept for
the entire year) for the following prices of gold: $1100, $1150, $1200.