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Risk Management and Derivatives – Winter

Project 2

What is this project?

The goal of the project is to give you hands-on opportunities to analyze option trading strategies and the pricing of options. You should present the qualitative and quantitative results in a short written report.

The due date is 8:00AM (Beijing), Jan 10th, 2023.

Please hand in an electronic copy of your word document, named as in the format ‘Student ID_Name’. This copy should be uploaded to the Assignment Section on CANVAS.

How is the project structured?

Question 1: Construct a straddle (buy a call and buy a put with the same exercise price) on November 2^nd, 2022 using stock options. The option data is provided in ‘data.xlsx’ file. Close the position on December 7^th, 2022.

(1) Show maximum gains and losses, and identify the breakeven price(s) at expiration on the straddle strategy by drawing a graph.

(2) Track the profits&losses of your strategy at the end of each trading day and present the results in a table. According to the calculated profits and losses, would you like to close the option positions prior to expiration?

(3) What kind of bet is this investor making; that is, what must this investor believe about APPLE’s stock price to justify this straddle strategy?

Question 2: Consider a binomial tree problem for an American option. On December 8^th, 2022, the stock price of APPLE was $142.65.

(1) Use one year of historical data to estimate appropriate values for u and d for the use in a two-step binomial option pricing model; the length of one time step is 1 day. The historical stock prices are given in the ‘data.xlsx’ file. (Tips: . The volatility () is calculated as the standard deviation of past daily returns*sqrt(252), assuming a year with 252 trading days.)

(2) Estimate the price of an American call option on APPLE stock with a strike price of $134 and a maturity of December 12^th, 2022 (the duration is two trading days). Assume that the continuously risk-free rate is 1.76% per annum.

Instructions on Written Report

The report must contain the following:

1. Title page: Course name; Your name; term and date.

2. Each question must be answered.

How will the project be graded?

The assessment for this project (accounting for 50% of the final mark) will be based on the following parameters:

1. Technical proficiency (80%): quality of qualitative and quantitative analysis; clarity of tables or figures.

2. Writing (20%): clarity and completeness of summary report.