Week 2 Options

Question 1

What are the different options?

Answer 1

Long and short call
Long and short put

Question 2

Whats the difference between put and call

Answer 2

Long call - make a profit if price goes up. Right to buy.

Long short- make a profit if price goes down. Right to sell.

Both have right to buy/sell not obligation unlike shorts.

Question 3

When would you and would you noy exercise call option?

Answer 3

Would: If S>X
Wouldnt: If S ≤ X

Question 4

What is the intrinsic value of a call and how to make profit?

Answer 4

-S - X is the intrinsic value
-Profit is made if S - X > premium.
-Call value = max [0, S - X].
S - X increases 1-for-1 with the asset price implying 45º line.

Question 5

When would you exercise put option?

Answer 5

If the spot price of the
asset is lower than the exercise price. (X>S).

Intrinsic value of the put is X – S.

Put value = max [0, X – S]

Question 6

What is the time value and intrinsic value of a call?

Answer 6

At S ≤ X the intrinsic value of the option is zero.
When S > X the option has both time value and intrinsic value.
C = TV + IV when S > X
C = TV when S ≤ X

Question 7

Assumptions of put call parity?

Answer 7

• Frictionless capital markets
• No-arbitrage conditions
• No restrictions on short-selling
• A risk-free rate exists

Question 8

What is put call parity?

Answer 8

Two portfolios (A and B):
A. One share of stock and a European Put (T, X)
B. European Call (T, X) and risk-free bond with face value X.

It has a special relationship between Put and Call options, with same terms, expiry date and exercise price.

At expiry
S ≤ X this means prices decrease. Thus call and put both have Value X. At S > X means prices increase. Both call and put have value S. So A and B are the same.

Question 9

What is the formula for Put-call parity?
What about when S=X?

Answer 9

-S0 + P = C + X(1+r)^-T. Prices are linked through this relationship.
When S=X: Use S0 as X so: X+P = C+ X(1+r)^-T.
P – C = -X + X(1+r)-T < 0.
P – C < 0. P < C.

Question 10

When is a call more valuable than a put?

Answer 10

when S > X(1+r)^-T

Question 11

What about put call parity for american options?
With dividends?

Answer 11

S - X ≤ C – P ≤ S - X(1+r)^-T

S –D –X ≤ C–P ≤ S-X(1+r)^-T

Question 12

European put call with dividends?

Answer 12

S – D + P = C + X(1+r)^-T