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Problem 3

The document presents a problem set focused on options trading strategies, including derivation of put-call parity and analysis of various strategies like butterfly spreads and straddles. It also involves calculating the value of a call option and developing a dynamic trading strategy to manage a stock portfolio. Additionally, it includes a scenario involving a gold mine lease, requiring the creation of a price path tree and valuation of the lease under specific conditions.

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Illyes Nouari
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3 views2 pages

Problem 3

The document presents a problem set focused on options trading strategies, including derivation of put-call parity and analysis of various strategies like butterfly spreads and straddles. It also involves calculating the value of a call option and developing a dynamic trading strategy to manage a stock portfolio. Additionally, it includes a scenario involving a gold mine lease, requiring the creation of a price path tree and valuation of the lease under specific conditions.

Uploaded by

Illyes Nouari
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

Problem Set 3

1. Derive put-call parity.

2. (a) (Butterfly spread). Suppose that an investor buys one call with
$55 strike price for $10, and one call with $65 strike price for 5.
He also sells two calls with $60 strike price for $7 each. All expire
in 6 months. Describe the payoff from this strategy. What would
cause an investor to follow this strategy?
(b) (Straddle) Investor buys a put and a call, both with strike price
of $70 and expiring in 3 months. The call costs $4 and the put
costs $3. Describe the payoff from this strategy. What would
cause an investor to follow this strategy?

3. Suppose that a stock currently sells for $10 and can rise of fall in value
by 10% each month. The risk free rate is 0.5% per month. What is
the value of a call option on the stock with exercise date in 2 months,
and exercise price of $9?

4. You own 100 shares currently worth $50 each. In each of the next 3
years the shares may rise by 12% or fall by 10%. Suppose that the
risk-free rate is zero. Derive a dynamic trading strategy to ensure that
your portfolio benefits fully from rises in share price, but never falls in
value below $4,500. What is the cost of this synthetic put?

5. (Harder than the others.) You are offered a 3 year lease on a gold
mine. It costs you $400 per ounce to extract gold and you can extract
up to 10,000 ounces per year if the price exceeds this. Gold currently
sells for $400 per ounce, and each year the price can either rise by 20%
or fall by 10%.

(a) Make out a tree describing the path of gold prices in each year.

1
(b) Assuming a zero risk-free rate, and knowing that the lease is
worth nothing at the end of the third year, work backwards to
find the current value of the lease.

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