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AFIN3029 Derivatives Instruments

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AFIN3029 Derivatives Instruments

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Task:

Question 1 (10 marks)

A) Assume the current volatility of oil is high. What options portfolio offers you a gain, from this high volatility, if you do not have a view on direction? (3 marks)

B) What is the directional view in a long-call butterfly spread? (3 marks)

C) Suppose that put options on a LYX stock with strike prices AUD 50 and AUD 55, costs AUD 4 and AUD 7, respectively. Create a bull spread and a bear spread using these options. Then construct a table that shows the profit and payoff for each of these spreads. (4 marks)

Question 2 (12 marks)

A) A stock is currently selling for AUD 61 per share. A call option with an exercise price of AUD 65 sells for AUD 4.12 and expires in 3 months.

i) If the risk-free rate of interest is 2.6% per year, compounded continuously, what is the price of a put option with the same exercise price? (3 marks)

ii) If the market price of the put option is AUD 3.00, explain how to construct a portfolio to make a riskless arbitrage profit. (3 marks)

B) A stock price is currently AUD 40 and it is known that at the end of three months it  will be either AUD 44 or AUD 36. We are interested in valuing a European call option.

i) Using the risk-free rate of 12% per annum; Apply the risk-neutral binomial model to value this European call option when the strike is AUD 42. (3 marks)

ii) If the delta of the above European call is 0.25, what is the delta of the European put for the same strike and maturity? (3 marks)
Question 3 (8 marks)

A) A stock price is currently AUD 60; the annual continuous risk-free rate is 5% and the volatility is 30% p.a.. What is the value of a two-year American put option with a strike price of AUD 62? (5 marks)

B) Briefly explain why it is not optimal to exercise an American call option on a nondividend paying stock before the expiration date. (3 marks)  

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