CHAPTER 20

Ifinvestorshaveunderestimatedvolatilitytheoptionprices

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Unformatted text preview: An option on a portfolio is less valuable than a portfolio of options on the individual stocks because, in the latter case, you can choose which options to exercise. 20. Consider each company in turn, making use of the put­call parity relationship: Value of call + Present value of exercise price = Value of put + Share price Drongo Corp. Here, the left­hand side [52 + (50/1.05) = 99.62] is less than the right­hand side [20 + 80 = 100]. Therefore, there is a slight mispricing. To take advantage of this situation, one should buy the call, invest $47.62 at the risk­free rate, sell the put, and sell the stock short. Ragwort, Inc. Here, the left­hand side [15 + (100/1.05) = 110.24) is greater than the right­ hand side [10 + 80 = 90]. Therefore, there is a significant mispricing. To take advantage of this situation, one should sell the call, borrow $95.24 at the risk­free rate, buy the put, and buy the stock. Wombat Corp. For the three­month option, the left­hand side [18 + (40/1.025) = 57.02]...
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This note was uploaded on 04/26/2013 for the course MATH 289Q taught by Professor Jamesbridgeman during the Fall '04 term at UConn.

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