6 Options II

S0 is the current price of jul 08 50 155 678 amgen

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Unformatted text preview: ract. π = F0 – IT, and if stock prices fall, your gain offsets the loss to your portfolio. • Alternatively, you could buy index put options. Your π = (K – IT) – p, and again, if stocks fall, your gain offsets the loss to your portfolio. • The premium p on stock index puts is the price of portfolio insurance. The more nervous the hedgers are, the more they will pay for the options. b) From stock index options, R. Whaley (1993) showed how to compute volatility indexes. • VIX - - volatility on S&P 500 index (was the S&P 100 until 2003) • VXN - - volatility on Nasdaq 100 index • VXD - - volatility on DJIA index 1) The VIX is the best known, and is called the “Investor Fear Gauge.” 2) Basically, the index is computed by looking at call and put premiums of at- the- money, 30- day S&P 500 index options (which are European- style and easier to value), and then using the BSM model to compute the implied volatility. (The actual formula for compu- tation is extremely complicated.) 3) The index is forward looking (unlike estimating σ using historical data). It represents the market’s current expectations about the riskiness or uncertainty in stock markets over the next 30 days. Ranges for interpreting the VIX: • Below 20 - - all expected to be calm • Between 20 and 30 - - typical levels in normal times • Over 30 - - stressful times expected ahead The VIX reached 80 during the financial crisis of 2008, and 100+ in October 1987. c) The CBOE introduced VIX futures (2004) and VIX options (2006), wh...
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