European options

:: European call and put options ::

:: Remark on option symbols ::

How is it possible that there are several option with the same strike price and the same expiration time?
obr

:: Payoff and profit diagrams in Scilab ::

obr [ex01payoff.sce] - Scilab file:
  • definition of the function for computing payoffs of call and put options
  • script for the plot below
Download and run it.

obr
Result:
obr
We can choose a format and save the plot - either using Export to (for example to png) ot Vectorial export to (for example to eps).

:: Exercises (1) ::

  1. Suppose that we have one put option with exercise price 60 USD which costs 7 USD and one call option with the same exercise price which costs 5 USD.
    • Plot payoff and profit diagrams. What expectation about future prices of the stock of the investor is revealed by this strategy?
    • When (for what values of the stock at the expiration time) is the strategy profitable?
    • What is the maximal possible profit? The maximal loss?

:: Moneyness ::

The term characterized the options according to the relation between the current stock price and the strike price of the option.

:: Combined strategies ::

Link: http://www.theoptionsguide.com/

:: Real option prices ::

:: Exercises (2) ::

  1. Choose one of the strategies listed above and construct its payoff and profit diagrams using real option prices. Under what circumstances will it bring profit?

:: Bounds on option prices ::

:: Practice problems ::

  1. Prove that p(S,obr,E1) obr p(S,obr,E2) for E1 obr E2 . Construct an example of an arbitrage in a case when this inequality does not hold (with concrete numbers).

  2. Prove that the function p(S,obr,E) is a convex function of the strike price. Construct an example of an arbitrage in a case when this property does not hold (with concrete numbers).

  3. Prove that S - E exp(-r obr) obr c(S,obr,E) obr S, where r is the interest rate. Construct an example of an arbitrage in a case when this inequality does not hold (with concrete numbers).

  4. Suppose that the interest rate is zero. The stock price is 10 USD and there are call and put options with strike price 12 USD which expire in one month. The call option costs 3 US and the put option costs 4 USD. Find an arbitrage.

  5. Consider the following pair of call and put options: they have the common strike price of 55 USD and they both expire in one year. The stock price is 53 USD and the call price is 0.1 USD higher than the put price. Determine the interest rate.

  6. Find combinations of call and put options which have the following payoffs:
    obr


  7. [Exam, 2013]
    Sketch the payoff of a strategy consisting of buying a put option with strike price 50 USD and selling a put option with strike price 30 USD. Give an example of such (positive) prices of these options, for which would this strategy lead to an arbitrage opportunity. Construct this arbitrage.



Financial derivatives - exercises, 2014
Beáta Stehlíková, FMFI UK Bratislava


E-mail: stehlikova@pc2.iam.fmph.uniba.sk
Web: http://pc2.iam.fmph.uniba.sk/institute/stehlikova/