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Options Valuation and Parity Analysis

The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

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Jaden Eu
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31 views3 pages

Options Valuation and Parity Analysis

The document contains solutions to 7 questions about valuing options on stocks, indices, currencies and futures. Key points: 1) Indices, currencies and futures can be valued like stocks that pay a continuous dividend yield equal to the index dividend yield, foreign interest rate, or risk-free rate respectively. 2) Put-call parity formulas are the same except the stock price is replaced by terms accounting for the dividend/interest rates. 3) Futures options have advantages like easier trading of the underlying and no delivery on exercise.

Uploaded by

Jaden Eu
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Tutorial solutions week 11

Question 1.
“Once we know how to value options on a stock paying a dividend yield, we know how to value
options on stock indices, currencies, and futures.” Explain this statement.

Answer
 A stock index is analogous to a stock paying a continuous dividend yield, the dividend
yield being the dividend yield on the index.
 A currency is analogous to a stock paying a continuous dividend yield, the dividend yield
being the foreign risk-free interest rate.
 A futures is analogous to a stock paying a continuous dividend yield, the dividend yield
being the risk-free interest rate.

Question 2.
How does the put–call parity formula for index/currency/futures options differ from put–call
parity for an option on a non-dividend-paying stock?

Answer
The put–call parity formula for index/currency/futures options is the same as the put–call parity
formula for non-dividend-paying stock options except

 The stock price is replaced by S0e-qT in the case of index options


 The stock price is replaced by S0e-rfT in the case of currency options
 The stock price is replaced by F0e-rT in the case of futures options

Question 3.
What are advantages of futures options over spot options?

Answer
 Futures contract may be easier to trade than underlying asset
 Exercise of the option does not lead to delivery of the underlying asset
 Futures options and futures usually trade in adjacent pits at exchange – not so relevant
now with electronic trading
 Futures options may entail lower transactions costs
Question 4.
Calculate the value of a three-month at-the-money European call option on a stock index when
the index is at 250, the risk-free interest rate is 10% per annum, the volatility of the index is 18%
per annum, and the dividend yield on the index is 3% per annum. What is the value of the
corresponding put option?

Answer
S0  250 , K  250 , r  010 ,   018 , T  025 , q  003 and

ln(250  250)  (010  003  0182  2)025


d1   02394
018 025
d 2  d1  018 025  01494
N(d1 ) = N(0.2394) = N(0.23) + 0.94 ∗ [N(0.24) − N(0.23)] = 0.5910 + 0.94 ∗ [0.5948 − 0.5910]
= 0.5946
N(d2 ) = N(0.1494) = N(0.14) + 0.94 ∗ [N(0.15) − N(0.14)] = 0.5557 + 0.94 ∗ [0.5596 − 0.5557]
= 0.5594
The call price is
c= 250*0.5946*e-0.03*0.25-250*0.5594* e-0.10*0.25=11.14
The put price is
p= c + Ke-rT- Se-qT=11.14+ 250* e-0.10*0.25-250*e-0.03*0.25=6.84

Question 5.
Calculate the value of an eight-month European put option on a currency with a strike price of
0.50. The current exchange rate is 0.52, the volatility of the exchange rate is 12%, the domestic
risk-free interest rate is 4% per annum, and the foreign risk-free interest rate is 8% per annum.
What is the value of the corresponding call option?

Answer
S0  052 , K  050 , r  004 , rf  008 ,   012 , T  06667

ln(052  050)  (004  008  0122  2)06667


d1   01771
012 06667
d 2  d1  012 06667  00791

N(d1 ) = N(0.1771) = N(0.17) + 0.71 ∗ [N(0.18) − N(0.17)] = 0.5675 + 0.71 ∗ [0.5714 − 0.5675]
= 0.5703
N(d2 ) = N(0.0791) = N(0.07) + 0.91 ∗ [N(0.08) − N(0.07)] = 0.5279 + 0.91 ∗ [0.5319 − 0.5279]
= 0.5315
N(−d1 )=1- N(d1 )=1-0.5703=0.4297
N(−d2 )=1- N(d2 )=1-0.5315=0.4685
The put price is
p = 0.50*0.4685*e-0.04*0.6667-0.52*0.4297*e-0.08*0.6667=0.0162
The call price is
c= p + Se-qT -Ke-rT= 0.0162+0.52*e-0.08*0.6667 - 0.50*e-0.04*0.6667=0.0223

Problem 6.
An index currently stands at 1,500. European call and put options with a strike price of 1,400
and time to maturity of six months have market prices of 154.00 and 34.25, respectively. The six-
month risk-free rate is 5%.What is the dividend yield?

Answer
c + Ke-rT = p + S0 e-qT
154  1400e00505  3425  1500e05q
 1500e-0.5q = 154+1400e-0.05*0.5-34.25 = 1485.18
 -0.5q = ln(1485.18/1500)= -0.0099
 q = -0.0099/(-0.5)= 0.0198 = 1.98%
Question 7.
An index currently stands at 696 and has a volatility of 30% per annum. The risk free rate of
interest is 7% per annum and the index provides a dividend yield of 4% per annum. Calculate
the value of a three month European put with an exercise price of 700. What is the value of a
three month European call also with an exercise price of 700?

Answer
S0 = 696, K=700, r=0.07, σ=0.3, T=0.25, q=0.04
696 0.32
ln (700) + (0.07 − 0.04 + 2 ) 0.25
𝑑1 = = 0.0868
0.3√0.25
𝑑2 = 𝑑1 − 0.3√0.25 = −0.0632
N(-𝑑1 ) = 0.4654
N(-𝑑2 ) = 0.5252
The put price is
p=700*0.5252*e-0.07*0.25-696*0.4654*e-0.04*0.25=40.60
The call price is
c= p + Se-qT -Ke-rT=40.60+696*e-0.04*0.25-700*e-0.07*0.25=41.82

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