Concept Questions 11

Prof. Itamar Drechsler

1. Which one-year option strategy will give the highest expected net profit if
a. you are very confident that the stock price will move VERY LITTLE
over the next year,
b. out-of-the-money options are much cheaper than at-of-the money options?
(a) Long a straddle
(b) Long a strangle
(c) short a straddle
(d) short a strangle
2. Which one-year option strategy will give the highest expected net profit if
a. you are very confident that the stock price will move A LOT over the
next year, b. out-of-the-money options are much cheaper than at-of-the
money options?
(a) Long a call and long a put
(b) Long a call and short a put
(c) Short a call and short a put
(d) short a call and long a put
3. If you own a European put option with 1 month till the strike date and
with strike price 50, the stock is currently trading at 45, and the riskless
interest rate is 5%, what is the intrinsic value of the put?
(a) zero
(b) 5
(c) 50 45 e.051
(d) 50 45 e.05/12
4. If you own a European call option with strike price 100, 1 year till expiration, the riskless interest rate is 1% and the stock is trading at 112,
what is the lowest price for which you should be willing to sell your option
(minimum value or adjusted intrinsic value)?
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(a) $12
(b) 112 100 e.011 = $13
(c) 112 100 e.01/12 = $12.08
(d) the option is worthless: $0
5. If the price on a call option with 1 year until maturity and a strike price of
100 is $3, and if the interest rate is .04 and the stock price is 98, what should
be the price on the put option with the same strike and same maturity?
(a) 3 98 + 100 = $5
(b) 3 + 98 100 = $1
(c) 3 + 98 100 e.04 = $4.92
(d) 3 98 + 100 e.04 = $1.08
6. Find the price of a European call with strike 75 and maturity 6 months.
The underlying stock is currently trading at 60, it has a volatility of 0.6
per year (continuously compounded) and it pays no dividends. The riskless
interest rate per year is 10 percent also continuously compounded. (you
will need a calculator to compute the BS formula)
(a) C0 = 0
(b) C0 = 3.41
(c) C0 = 6.25
(d) C0 = 11.45
7. If a stock is trading at 200 and you own a call with strike price 50, the
current option price will be very close to
(a) the intrinsic value
(b) the adjusted intrinsic value
(c) zero
(d) the price of the put
8. Fix the maturity, the exercise price and the risk-free rate. The price of the
call is higher for stocks with
(a) Low volatility
(b) High volatility
(c) a low current price
(d) None of the above
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9. If the riskless interest rate is lower, the value of a put option, all else
constant, is
(a) lower
(b) higher
(c) constant
(d) its ambiguous
10. If the call option on stock A is more expensive than the same call option
on stock B, the stocks are currently trading at the same price and they pay
the same dividend, then
(a) The risk-free rate corresponding to stock A must be less than the one corresponding to stock B
(b) The risk-free rate corresponding to stock A must be more than the one corresponding to stock B
(c) Stock A must be less volatile than stock B
(d) Stock A must be more volatile than stock B
11. Suppose you are short a call option. To hedge your risk exposure, you
would like to cover your position by buying the underlying stock. What
exactly do you do between now and expiration date?
(a) Buy Delta = N(d1) shares of the stock initially and hold these shares until expiration. (where N(d1) is given by the Black and Scholes formula)
(b) Buy Delta = N(d2) shares of the stock initially and hold these shares until expiration. (where N(d2) is given by the Black and Scholes formula)
(c) Buy Delta = N(d1) shares of the stock initially and keep changing your portfolio
until expiration, as Delta moves over time.
(d) Buy Delta = N(d2) shares of the stock initially and keep changing your portfolio
until expiration, as Delta moves over time.