Homework 11
1.
Draw the following:
A.
The gross payoffs(do not factor in the cost of the options) of buying 2 calls
and one put, graph this over stock price(x) and payoff(y) space. Assume they
have the same strike.
Payoff
Strike
Price
The right hand side is twice as steep, slope is 2 of right hand side, slope is
negative one.
B.
Draw the gross payoffs from shorting one call and one put, with the same
strike.
Payoff
Strike
Price
C. Explain which of these graphs must you pay to have these potential payoffs
and which would you expect to receive money to take the associated payoff
structure?
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View Full DocumentYou would pay for the options in part A as there is no potential downside so it must cost
you something for expected gains.
Part B options have negative expected payoffs so
you would have to be compensated for this position.
2.
A.
Explain put call parity, why does it work? Explain each part of the equation.
Put call parity is the idea that you can recreate a put or a call with a combination of tbills
stock and a call or put. This holds due to arbitrage pricing theory.
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 Spring '09
 Hull
 Derivative, Mathematical finance

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