Ch.

7: Option Pricing

CHAPTER 7

OPTION PRICING

Problem 1

3-month call: Pay-off

Exercise price, E 51
Current share price, S0 50
Share price at expiration, St 47 0
54 3

4
Call Value

3
2
1
0
0 47 50 51 54
Share Price

Problem 2

6-month call option (short): Pay-off

Exercise price, E 100
Current share price, S0 100
Share price, St 110 -10
90 0

0 90 100 110
0
Call Value

-5

-10

-15
Share Price

Problem 3

6-month call option: Pay-off

Exercise price, E 98
Call premium 3
Current share price, S0 100
Share price at expiration, St 108 7
95 0

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

8
6
Call Value

4
2
0
-2 0 95 98 99 100 101 108
-4
Share Price

Problem 4

Call option: Pay-off

Exercise price, E 42
Premium 5
Current share price, S0 44
Share price at maturity, St 45 -2
43 -4

Problem 5

3-month put option: Pay-off

Exercise price, E 101
Current share price, S0 100
Share price at expiration, S 97 4
104 0

0
97 100 101 104

Problem 6

6-month put option (short): Pay-off

Exercise price, E 100
Current share price, S0 100
Share price at maturity, St 110 -10
90 0

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Ch. 7: Option Pricing

Value of Put to Seller

90 100 110
0
Value of Put

-5

-10

-15
Share Price

Problem 7

6-month put option: Payoff

Exercise price, E 96
Premium 4
Current share price, S0 100
Share price at expiration, St 108 -4
95 -3

Value of Put

91 92 93 94 95 96 100 108
2
Value of Put

0
-2
-4
-6
Share Price

Problem 8

3-month put: 30 16
Exercise price, E 50 40 6
Premium 4 50 -4
Current share price, So 52 60 -4

Value of Put to Buyer

20
Value of Put

0
30 40 50 60
-20
Share Price

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 9

6-month put option (short): Share price Payoff

Exercise price, E 70 60 -5
Premium 5 65 0
70 5
75 5

Value of Put to Seller

10
Value of Put

5
0
-5 60 65 70 75

-10
Share Price

Problem 10

Put option: Pay-off

Exercise price, E 42
Premium 5
Current market price, So 44
Share price at expiration, St 45 -5
43 -5

Problem 11

Call option: Pay-off

Exercise price, E 50
Current share price, S0 45
Share price at maturity, St 65 15
40 0
No of shares 50
Value of shares 3250 750 4000

Problem 12

Share price at maturity, St 90 97 100 110

Call option: E 100 100 100 100
Pay-off from call 0 0 0 10
Put option: E 97 97 97 97
Pay-off from put 7 0 0 0
Total pay-off 7 0 0 10

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Ch. 7: Option Pricing

Value of Portfolio of Put & Call

Pay-off 15

10

0
90 97 100 110
Share Price

Problem 13

Share price at maturity, St 90 97 100 110

Call option: E 100 100 100 100
Call premium 3 3 3 3
Pay-off from call -3 -3 -3 7
Put option: E 97 97 97 97
Put premium 5 5 5 5
Pay-off from put 2 -5 -5 -5
Total pay-off -1 -8 -8 2

Value of Put & Call

10

5
Value

0
90 97 100 110
-5

-10
Share Price

Problem 14

3-month call & put:

Share price at maturity, St 52 45
Call option: E 50 50
Call premium 4 4
Pay-off from call -2 -4
Put option: E 50 50
Put premium 2 2
Pay-off from put -2 3
Total pay-off -4 -1

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 15

Share (long) + call (short):

Current share price, S0 100
Risk-free rate, rf 0.12
Exercise price, E 97
Share price at expiration, St 108 90
Binomial approach:
Call option pay-off 11 0
(108∆-11)=(90∆-0)
∆(delta)=(11-0)/(108-90) 0.611
Portfolio value at maturity:
(108 × 0.611)-11 or (90 × 55
0.61)
PV of portfolio: 52.88
PVF, 4% for 3 months 1/(1.04) 0.9615
Value of call, C:
(S0 × 0.611- C) = 52.88, C = 8.23
100*.611-52.88
Risk-neutral method:
Probability of price increase: 0.778
p × 8 + (1 - p) × -10 = 4,
p = 14/18
Value of call at maturity Ct: 11*.778 8.56
PV of call, C: 8.23

Problem 16

Share (long) + call (short):

Current share price, S0 100
Risk-free rate (annual), rf 0.1
Exercise price, E 100
Share price at expiration, St 115 90
Call option pay-off 15 0
PVF, 5% for 6 months 1/(1.05) 0.9524
Risk-neutral method:
Probability of price increase: 0.600
p × 15 + (1 - p) × -10 = 5,
p = 15/25
Value of call at maturity Ct: 15 x 0.6 9
PV of call, C: 8.57

Problem 17

Current market price, S0 60

Change in price at maturity 0.150 -0.10
Price at expiration 69 54
Risk-free rate (annual) 0.090
Risk-free rate for 2 months 0.015
Exercise price, E 65
Value of call:

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Ch. 7: Option Pricing

Probability of price increase: 0.46

p × 15 + (1 - p) × -10 =1.5,
p = 11.5/25
Value of call at maturity: (69 1.84
– 65) × 0.46
PV of call, C: 1.84/1.015 1.81
Present value of put:
P = C - S + PV of E 5.85

Problem 18

Risk-free rate 0.1

Time to expiration (years) 0.5
Exercise price, E 55
Current share price, S0 60
Volatility (SD) 0.4
PV of Exercise price, PV (E) 52.32
0.6258

d2 =
[ ]
ln (S / E ) + rf − σ2 / 2 t
σ t 0.3430
N(d1) 0.7343
N(d2) 0.6342
Value of call
C = SN(d1 ) − Ee − rf t N(d 2 ) 10.88

Value of put
P = C − S + Ee − rf t 3.20
Delta 0.7343

Problem 19

Risk-free rate 0.12

Time to expiration (years) 0.33333
Exercise price, E 93
Current share price, S 86
Volatility (SD) 0.6
PV of Exercise price, PV (E) 89.35

d1 =
[
ln(S / E ) + rf + σ 2 / 2 t ] 0.06278
σ t

d2 =
[ ]
ln (S / E ) + rf − σ2 / 2 t
-0.2836
σ t
N(d1) 0.5250
N(d2) 0.3883
Value of call
C = SN(d1 ) − Ee − rf t N(d 2 ) 10.45
Value of put
13.81
P = C − S + Ee − rf t
Delta 0.5250

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 20

Risk-free rate 0.12

Time to expiration (years) 8
Face value of debt, E 95
Current value of firm, S 230
Volatility (SD) 0.25
PV of Exercise price, PV (E) 36.37

2.9616

d2 =
[ ]
ln (S / E ) + rf − σ2 / 2 t
σ t 2.2545
N(d1) 0.9985
N(d2) 0.9879
Value of equity 193.71
C = SN(d1 ) − Ee − rf t N(d 2 )
Market value of debt 36.29

Problem 21

Infosys call option 1:

Exercise price 3400
Premium 186.15
Infosys call option 2:
Exercise price 3500
Premium 38.1
Current share price 3469
Lot size 100
Expected share price range 3200 3300 3400 3500 3600 3700
Call option 2 bought: gain 0 0 0 0 100 200
Premium -38.1 -38.1 -38.1 -38.1 -38.1 -38.1
Pay-off -38.1 -38.1 -38.1 -38.1 61.9 161.9
Call option 1 sold: loss 0 0 0 -100 -200 -300
Premium 186.15 186.15 186.15 186.15 186.15 186.15
Pay-off 186.15 186.15 186.15 86.15 -13.85 -113.85
Net pay-off 148.05 148.05 148.05 48.05 48.05 48.05

Problem 22

Current share price 123.7

Daily volatility 2.74%
Expected maximum share price 142.5
Put option exercise price 150
Premium 7.50
Possible share price at expiration, S 120 130 140 150 160 170
Premium -7.50 -7.50 -7.50 -7.50 -7.50 -7.50
Gain 30 20 10 0 0 0
Net pay-off 22.50 12.50 2.50 -7.50 -7.50 -7.50

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Ch. 7: Option Pricing

30.00

22.50 Premium
Gain

15.00 Net pay-off

7.50

0.00
120 130 140 150 160 170
-7.50

Problem 23

Infosys put option:

Exercise price 3400
Premium 37.5
Infosys call option:
Exercise price 3300
Premium 32.5
Spot share price 3370
Lot size 100
Share price range 3200 3300 3400 3500 3600 3700
Call option payoff:
Premium -32.5 -32.5 -32.5 -32.5 -32.5 -32.5
Gain 0 0 100 200 300 400
Payoff -32.5 -32.5 67.5 167.5 267.5 367.5
Put option payoff:
Premium -37.5 -37.5 -37.5 -37.5 -37.5 -37.5
Gain 200 100 0 0 0 0
Payoff 162.5 62.5 -37.5 -37.5 -37.5 -37.5
Net payoff 130 30 30 130 230 330