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d1 =
=
= 0.4632
t
0.25 1
N (d1 ) = N (0.46) = 1 0.6772 = 0.3228
= 0.1922
d1 =
0.25 0.75
N (d1 ) = N (0.19) = 1 0.5753 = 0.4247
Problem 2
For a bear spread, you are given:
(i) The stocks price is 75.
(ii) The stock pays no dividends.
(iii) The stocks volatility is 0.3.
(iv) The bear spread consists of buying a 70-strike European put and selling a 60-strike European put.
(v) Time to expiry of the options is 6 months.
(vi) The continuously compounded risk-free rate is 4%.
Calculate your profit on the bear spread after 3 months if the stock price is 73 then.
Solution. At time T=0 we are given: Eur. puts, t = 0.5, S = 75, = 0, = 0.3, r = 0.04.
For a 70-strike put, the value is:
P = Kert N (d2 ) Set N (d1 ), where
2 0.5
ln 75
+
0.04
+
0.5
0.3
ln (S/K) + (r + 12 2 )t
0.1115
d1 =
= 70
=
= 0.5256
0.2121
t
0.3 0.5
N (d1 ) = N (0.53) = 1 0.7019 = 0.2981
0.3
0.2656
d1 = 60
=
= 1.2523
0.2121
0.3 0.5
N (d1 ) = N (1.25) = 1 0.8944 = 0.1056
d1 =
= 0.4214
0.3 0.25
N (d1 ) = N (0.42) = 1 0.6628 = 0.3372
d1 =
= 1.4491
0.3 0.25
N (d1 ) = N (1.45) = 1 0.9265 = 0.0735
Problem 3
For a European put option on a stock with one year to expiry, you are given:
(i)
(ii)
(iii)
(iv)
(v)
Determine the implied volatility of the stock using the Black-Scholes formula.
Solution. We are given: Eur. put, t = 1, S = 50, K = 50, = 0.04, r = 0.04, P = 6.22.
P = Kert N (d2 ) Set N (d1 ), where
ln (S/K) + (r + 12 2 )t
d1 =
= 0.5 t = 0.5
t
N (d1 ) = N (0.5) = 1 N (0.5)
d2 = d1 t = 0.5 t t = 0.5
N (d2 ) = N (0.5)
P = Kert N (d2 ) Set (1 N (d2 )) = N (d2 )[Kert + Set ] Set
P + Set
6.22 + 50e0.04
54.2595
=
=
= 0.5647
0.04
rt
t
2 50e
96.0789
Ke
+ Se
0.16
= 0.32
d2 0.16 d2 = 0.16 = 0.5 =
0.5
N (d2 ) =
Problem 4
For a 91-day European call option on a stock, you are given:
(i)
(ii)
(iii)
(iv)
(v)
The
The
The
The
The
q
d1 =
= 45
91
t
0.25 365
91
365
0.0975
=
0.1248
Problem 5
For 3-month European call options on a stock, you are given:
(i) The stock price is 60.
(ii) The stock pays no dividends.
(iii) The annual volatility is 20%.
(iv) The continuously compounded risk-free interest rate is 8%.
Page 4 of 9
d1 =
=
=
= 1.12
0.1
t
0.2 0.25
N (d1 ) = N (1.12) = 0.8686
55 = et N (d1 ) = N (d1 ) = 0.8686
= 0.5504
d1 =
0.2 0.25
N (d1 ) = N (0.55) = 1 0.7088 = 0.2912
65 = et N (d1 ) = N (d1 ) = 0.2912
Problem 6
You are given the following information for a delta-hedged portfolio for a call option on a stock:
(i) The underlying stocks price is 45.
(ii) The continuous annual dividend rate of the stock is 0.025.
(iii) = 0.35
(iv) The options expiry is 1 year.
(v) The continuously compounded risk-free interest rate is 5%.
Page 5 of 9
Determine the two stock prices at the end of one week for which there would be approximately no gain
or loss for the delta-hedged portfolio.
Solution. Price movement with no gain or loss to delta-hedger: the money-maker would break even if
the stock moves by about one standard deviation around the mean to either
S + S h or S S h
r
7
S + S h = 45 + 45 0.35
= 47.18
365
r
7
S S h = 45 45 0.35
= 42.82
365
Problem 7
For a 1-year European call option on a stock, you are given:
(i)
(ii)
(iii)
(iv)
(v)
Determine the approximate change in the value of the call if the stocks price decreases to 49 instantaneously.
Solution. Delta-gamma-theta approximation
1
C(St+h ) = C(St ) + + 2 + h
2
Since the stocks price decreases to 49 instantaneously, = 0.
call = put + et = 0.5 + e0.031 = 0.4704
call = put = 0.03
Hence,
C(S1 ) C(S0 ) = 0.4704(1) + 0.5 0.03 1 = 0.4554
Problem 8
For a European call option on a nondividend paying stock with one year to expiry, you are given:
(i)
(ii)
(iii)
(iv)
(v)
The price of the stock jumps to 60.50 and the price of the option increases by 0.0985.
Determine the implied volatility of the stock based on the delta-gamma approximation.
Page 6 of 9
Solution.
C(S1 ) C(S0 ) = + 0.52
0.0985 = call 0.5 + 0.5 0.0524 0.52
call = 0.1839 = et N (d1 ) = N (d1 )
2
ln 60
0.09415 + 0.5 2
70 + 0.06 + 0.5
d1 0.9 =
=
udS = 86.4
dS = 72
d2 S = 57.6
P
Pd
Pdd = 42.4
Page 7 of 9
e(r)h d
e0.030.5 0.8
=
= 0.5378
ud
0.4
1 p = 0.4622
p =
Problem 10
You are given the following information for two European options on a stock priced using the BlackScholes formula:
0.023
11.327
-0.01
0.85
0.005
0.03
Key: D
Page 8 of 9
Solution. Let x1 be the number of shares of stock purchased or sold and x2 be the number of 55-strike
calls purchased or sold to delta-gamma hedge a sale of a 50-strike put. Then:
x1 + 0.85x2 = 0.01
0.03x2 = 0.005
x2 = 0.005
0.03 = 0.166
x1 = 0.01 0.85 0.166 = 0.15166
Thus, to delta-gamma hedge a sale of a 50-strike put the market-maker will need to sell 0.15 shares of
stock and buy 0.17 55-strike calls for the total investment of 0.15166 70 + 0.166 11.327 = 8.73 .
Page 9 of 9