Financial Derivatives (N1559) – Spring 2024 Seminar Questions Week 4

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Financial Derivatives (N1559) – Spring 2024

Seminar  Questions  Week 4

Please work through the seminar questions BEFORE attending the seminar. Solutions to the questions will be provided on Canvas. If you would like to discuss any of the Quiz questions in the seminar, please email your tutor which details of which questions you would like to be covered.

1.  (JC  16.12)   It  it true that the lower the exercise price, the more valuable the call?  Explain your answer.

2.  (HSBC  Buffered Strategies)   Reconstruct the payoff diagrams of the two trading strategies mentioned in the HSBC structured product brochure, i.e., the buffered index notes, and the buffered “AMPS”.

3.  (JC 16.1)  Use the following data for European options:  Call price = $5, risk-free continuously compounded interest rate r = 5% per year, stock price S = $55, strike price K = $55, time to maturity T = 1 month.

If the quoted put price is pQ  = $9, show how to capture arbitrage profits in this market.

4.  (JC 16.15)  Can you make arbitrage profits from the European call prices in the table below? If so, give two such examples of arbitrage, neatly showing the portfolio construction as well as the various cash flows. The stock price is $40.

Strike Price               Expiration Month

April          July         September

35                 1             6                   3

40                 2             5                   6

5.  (Data question) Download the excel file OptionQuotes.xls from Canvas. The file contains put and call option data for Apple (prices  are recorded on 30 December  2016). Answer the questions below (using Excel) and make reasonable assumptions if you need to (justify these), or add further realistic market data (if required).

(a)  Determine the moneyness of the options traded. Moneyness is defined as K/S and hence measures whether options are in-the-money or out-of-the-money (an at-the-money options has a moneyness of one). Which options are most liquid on the day (most trading volume/dollar trading volume)?

(b)  What is the price of a long ATM straddle? Was the trade profitable?

(c)  Assume the options are European-style vanilla options. Are there any violations of put-call parity in the data?  If so, do you think these violations are exploitable?

Now assume the options are of American type (equity options usually are).

(d)  How would this alter your conclusions from (c)?

(e)  Would you consider exercising any of the call options early?

(f)  Do the call options lie within their lower and upper bounds?