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1. What happens to the value of a call option if the time to expiration is increased?
2. All option pricing models are based on the concept of a riskless hedge. Describe what this means. 3. What is the difference between an exercise price and an exercise value?
4. When the exercise price exceeds the current stock price a put option is said to be _________.
5. Options sold without the stock to back them up are called__________ options.
6. If you exercise one call option contract, how many shares of stock will you get?

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Jamar Ferry
Jamar FerryLv2
28 Sep 2019
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Question 3

Consider a stock currently worth $80 (S = 80) that can go up or down by 25 percent per period. The exercise price is $80 (X = $80) and the risk-free rate is 5 percent (r = .05). The option will expire at the next period (t = 1). You try to find a theoretically fair value of the call using a one-period binomial option pricing model. Answer the following questions. (Hint: See Ch 16 Teaching Notes and Excel Spreadsheet)

Compute the u and d in the binomial option pricing model such that the stock prices at the next period are Su and Sd.

What are two possible stock prices at the next period?

What are the intrinsic values at expiration of a European call option if the stock goes up and down?

Compute two values at expiration of a European call option (Cu and Cd)?

Compute the binomial probability (p)?

Find the theoretical fair value of the call option today using the one-period binomial pricing model.

Compute the riskless hedge ratio (h).

In order to construct a riskless hedge position by buying stocks and selling 1,000 calls using the riskless hedge ratio (h). How many stocks should you buy at what price? At what price should you sell the calls?

Compute the initial value of the riskless hedge position (V0).

Compute the market values of the riskless hedge position at the next period if the stock goes up (Vu) and goes down (Vd).

Find the rate of return on the riskless hedge position (R).

1. You have purchased a call option contract on Smith & Smith common stock. The option contract is for 100 shares. The option has an exercise price of $43.00 and S & S’s stock currently trades at $40.00. The option premium is quoted at $2.00.

a. If S & S’s stock price rises to $44.00, while you exercise the option? Calculate your net profit/loss on the option contract if.

b. If S & S’s stock price rises to $48.00, while you exercise the option? Calculate your net profit/loss on the option contract if.

c. If the stock price rises to $42.00, would you exercise or not exercise the option and what would be your gain or loss?

d. You will make a profit on the option if the S & S stock price rises above what amount?

To earn a profit, you must recoup the price you paid for the call, plus the exercise price:

Please show all work and explanations

please need some help with these three questions im stuck on

Problem 3

Suppose an investor have a put option. What will happen if the stock price on the exercise date is below the exercise price?

A. The seller will need to deliver stock to the owner of the option. B. The seller will be obliged to buy stock from the owner of the option. C. The owner will not exercise his option.
D. The option will extend for nine more months.
E. None of the above options.

Problem 5

Suppose an investor sells one share of stock and buys a call option on the stock. What will be the value of her investment on the final exercise date if the stock price is above the exercise price? (Ignore transaction costs.)

A. The value of two shares of stock.
B. The value of one share of stock plus the exercise price. C. The exercise price.
D. The value of one share of stock minus the exercise price. E. None of the above options.

10. All else equal, as the underlying stock volatility decreases:

A. The put price increases.
B. The put price decreases.
C. The call price increases.
D. There is no effect on put price.
E. The put price can either increase, decrease, or remain the same.

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