case03sol

case03sol - Introduction to derivatives Fall 2011 BUSI 588...

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Introduction to derivatives, Fall 2011 BUSI 588, Case 3 solutions Solutions to Rocinante: put-call parity arbitrage 1. (*) The following table produces the payoﬀs from the two diﬀerent strategies. Gold price Call K=110 Lend 100 Strategy (a) Gold Put K=110 Strategy (b) 85 0 110 110 85 25 110 90 0 110 110 90 20 110 95 0 110 110 95 15 110 100 0 110 110 100 10 110 105 0 110 110 105 5 110 110 0 110 110 110 0 110 115 5 110 115 115 0 115 120 10 110 120 120 0 120 125 15 110 125 125 0 125 130 20 110 130 130 0 130 135 25 110 135 135 0 135 Cost 10.25 100 110.25 110 8.15 109.60 What the payoﬀ table reveals is that a protective put (strategy b = asset + put) has exactly the same payoﬀs as a ﬁduciary call (strategy a = call + cash). Since in our case strategy a has a cost of 110.25, and strategy b has a cost of 109.60, no rational investor would choose the ﬁduciary call strategy, but rather invest in the protective put portfolio. One can actually perform the analysis a bit more elegantly using the type of payoﬀ tables introduced in the Rinconete case. Letting S * denote the price of gold in one-year we can write out the payoﬀs from the two trading strategies as follows. Today

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case03sol - Introduction to derivatives Fall 2011 BUSI 588...

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