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Lecture 8 (part 2)

# Stockprice44 putprice7 sellcallreceipt1

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Unformatted text preview: tion of Options Combination of Options ­ Offsetting Strategy If we further include initial cash outlays. Stock price = \$44 Put price = \$7 Sell call receipt = \$1 Initial Cash outlay = \$44 + \$7 ­ \$1 = \$50 Your return = (\$55 ­ \$50)/\$50 = 10% Hence, to maintain a riskfree return, the prices must be as such, otherwise arbitrage opportunities will exist. Put – Call Parity Put – Call Parity The value of a put and call with the same exercise price and expiry date are related to each other. Model C = S – [X / (1+RF)t] + P Where C = price of call S = stock price P = price of put X = exercise price RF = risk free rate Option Pricing Option Pricing 2­state Option Model Assume a market where there are only 2 possible stock prices at the end of the year. Current stock price is \$40. A call option exists at X of \$35, 1 year expiry. What is the value of the call option? Option Pricing Option Pricing Examine the payoffs at expiry: Stock price Buy Stock Buy Call (X = \$35) \$30 \$30 0 \$50 \$50 \$15 Range of Payoff \$20 \$15 To creat...
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