CHAPTER 22

2. a. b. c. The calls are in the money. The intrinsic value of the calls is $3. The puts are out of the money. The intrinsic value of the puts is $0. The Mar call and the Oct put are mispriced. The call is mispriced because it is selling for less than its intrinsic value. If the option expired today, the arbitrage strategy would be to buy the call for $2.80, exercise it and pay $80 for a share of stock, and sell the stock for $83. A riskless profit of $0.20 results. The October put is mispriced because it sells for less than the July put. To take advantage of this, sell the July put for $3.90 and buy the October put for $3.65, for a cash inflow of $0.25. The exposure of the short position is completely covered by the long position in the October put, with a positive cash inflow today. Each contract is for 100 shares, so the total cost is: Cost = 10(100 shares/contract)($7.60) Cost = $7,600 b. If the stock price at expiration is $140, the payoff is: Payoff = 10(100)($140 110) Payoff = $30,000 If the stock price at expiration is $125, the payoff is: Payoff = 10(100)($125 110) Payoff = $15,000 c. Remembering that each contract is for 100 shares of stock, the cost is: Cost = 10(100)($4.70) Cost = $4,700 The maximum gain on the put option would occur if the stock price goes to $0. We also need to subtract the initial cost, so: Maximum gain = 10(100)($110) $4,700 Maximum gain = $105,300 If the stock price at expiration is $104, the position will have a profit of: Profit = 10(100)($110 104) $4,700 Profit = $1,300 d. At a stock price of $103 the put is in the money. As the writer, you will make: Net loss = $4,700 10(100)($110 103) Net loss = $2,300

3.

a.

At a stock price of $132 the put is out of the money, so the writer will make the initial cost: Net gain = $4,700 At the breakeven, you would recover the initial cost of $4,700, so: $4,700 = 10(100)($110 ST) ST = $105.30 For terminal stock prices above $105.30, the writer of the put option makes a net profit (ignoring transaction costs and the effects of the time value of money). 6. Using put-call parity and solving for the put price, we get: $47 + P = $45e(.026)(3/12) + $3.80 P = $1.51 7. Using put-call parity and solving for the call price we get: $57 + $4.89 = $60e(.036)(.5) + C C = $2.96 10. Using the Black-Scholes option pricing model to find the price of the call option, we find: d1 = [ln($46/$50) + (.06 + .542/2) (3/12)] / (.54 d2 = .1183 (.54 N(d1) = .4529 N(d2) = .3489 Putting these values into the Black-Scholes model, we find the call price is: C = $46(.4529) ($50e.06(.25))(.3489) = $3.65 Using put-call parity, the put price is: Put = $50e.06(.25) + 3.65 46 = $6.90 12. The delta of a call option is N(d1), so: d1 = [ln($74/$70) + (.05 + .562/2) .75] / (.56 N(d1) = .6680

3 / 12 ) = .1183

3 / 12 ) = .3883

.75 ) = .4344

For a call option the delta is .6680. For a put option, the delta is: Put delta = .6680 1 = .3320 The delta tells us the change in the price of an option for a $1 change in the price of the underlying asset. The value of the debt is the firm value minus the value of the equity,