ExerciseD3 - EC3070 FINANCIAL DERIVATIVES Exercise 3 –...

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Unformatted text preview: EC3070 FINANCIAL DERIVATIVES Exercise 3 – Trading Strategies Table 1 below (Hull: Table 1.2, p. 7) contains information on the prices different call and put options on an Intel stock with the same expiration date (October) had on the 12th of September 2006: Table 1 Strike Price Oct Call Oct Put 15.00 4.650 0.025 17.50 2.300 0.125 20.00 0.575 0.875 22.50 0.075 2.950 25.00 0.025 5.450 Intel Option Prices (Sept 12, 2006; Stock Price=19.56); (Table 1.2 page 7, Hull); Source: CBOE 1. (Use Table 1) a. Explain how a strangle can be created using a call option with strike price of $22.50 and a put option with strike price of $17.50. What is the pattern of profits from the strangle? b. Explain how to create a strangle with a call option with strike price of $25.00 and a put option with strike price of $15.00. What is the pattern of profits from the new strangle? c. Suppose you try to create a strangle using a call option with strike price of $17.50 and a put option with strike price of $22.50. What is the result? d. Compare the profit function of the strategies in your answers to (a), (b) and (c). e. What is the difference between a straddle and a strangle? 2. (Use Table 1) a. Create a butterfly spread strategy using call options with strike prices of $17.50, $20.00 and $22.50. b. Draw a diagram showing an investor’s profit and loss as a function of the stock price at maturity. c. For what range of the underlying stock price will this strategy lead to a loss? d. What profit will it yield if the stock had a spot price at maturity equal to $20. e. Create another butterfly spread using put options with strike prices $15, $20 and $25. f. For what range of the underlying stock price will this strategy lead to a loss? g. What profit will it yield if the stock has a spot price at maturity equal to $20. h. Under which circumstances would you advise an investor to acquire a butterfly spread? 3. (Use Table 1) a. Create a bull spread using call options with strike prices $17.50 and $22.50. b. Create a bear spread using put options with strike prices $17.50 and $22.50. c. The combination of the two portfolios above creates a box spread. Show that the profit from this strategy is equal to the difference among the two strike prices for any value of the spot price at maturity. d. Show that two of the options used to create the box spread can be combined to create a long forward position, while the other two can be combined to create a short forward position. 4. Draw a diagram showing an investor’s profit and loss as a function of the stock price at maturity for portfolios consisting of: a. One share and a short position in one call option. b. Two shares and a short position in one call option. c. One share and a short position in two call options. d. One share and a short position in four call options. 5. Use the put‐call parity to relate the initial investment for a bull spread created using calls to the initial investment for a bull spread created using puts. References: Hull, chapters 1, 10. ...
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This note was uploaded on 03/02/2012 for the course EC 3070 taught by Professor D.s.g.pollock during the Spring '12 term at Queen Mary, University of London.

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