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Assignment 2

This document provides instructions for an assignment involving pricing a European call option with the Black-Scholes formula and Monte Carlo simulation. Students are asked to: 1) Simulate stock price paths and plot 5 examples. 2) Calculate the Black-Scholes price. 3) Use Monte Carlo simulation with varying numbers of simulations to estimate the price and its 95% confidence interval, comparing the results to the Black-Scholes price and discussing how the confidence interval length changes with additional simulations. The document also provides instructions for calculating the VIX index using option data and the methodology described in another reference document. Students are asked to calculate inputs like time to expiration, forward index levels, variance

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114 views

Assignment 2

This document provides instructions for an assignment involving pricing a European call option with the Black-Scholes formula and Monte Carlo simulation. Students are asked to: 1) Simulate stock price paths and plot 5 examples. 2) Calculate the Black-Scholes price. 3) Use Monte Carlo simulation with varying numbers of simulations to estimate the price and its 95% confidence interval, comparing the results to the Black-Scholes price and discussing how the confidence interval length changes with additional simulations. The document also provides instructions for calculating the VIX index using option data and the methodology described in another reference document. Students are asked to calculate inputs like time to expiration, forward index levels, variance

Uploaded by

keithxiaoxiao096
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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McGill Desautels

Daniel Andrei, Financial Derivatives FINE 448, Winter 2022

Assignment #2

Due date: Thursday, Apr. 7, 5pm


This is an open book group assignment. While you are not allowed to copy from
different groups, you are encouraged to discuss conceptual problems with all your
colleagues.
No late assignments will be accepted, no exceptions. Please send the assignment
by email (PDF file) to [email protected] and [email protected].
Make sure your answers are clear and legible. Write down clearly the names of all
group members on the assignment. No need to send your codes.
Any appeal to your grade must be submitted in writing no later than one week
after the grades have been announced. A request for a re-grade will result in a full
second evaluation of all questions. The new outcome may be higher, the same, or
lower than the initial grade. For clarification questions about the assignment, please
consult with Nan Ma, the T.A. of the class. Alternatively, you can consult with me
during office hours.
No more questions will be answered 36 hours before the submission
deadline. Good luck!

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1 Black-Scholes: Closed Form Solution vs. Monte-Carlo Simulation
The purpose of this exercise is to price a vanilla call option with Monte-Carlo
simulation and compare the result with the closed-form formula. The simulation will
also provide a confidence interval for the option price. We will understand how the
length of this confidence interval changes as we increase the number of simulated
paths.
The price of a stock today is S0 = 100. Consider a European call option with
maturity 3 months (T = 1/4) and strike price K = 100. We make the following
parametric assumptions: r = 0.05, σ = 0.2, and δ = 0.

a. Simulate and plot 5 paths for the stock price under the risk-neutral measure.
Use 5 minutes time-increments (there are 8 × 12 = 96 increments each day and
90 days until maturity).

b. Find the Black-Scholes call option price.

c. Find the option price and its 95% confidence interval by Monte-Carlo simu-
lation. You do not have to simulate the entire paths here—since the option
is European, you will have to simulate only the final price ST . Do this for
100; 1,000; 1,000,000; and 100,000,000 simulations. Discuss how the length of
the confidence interval changes with the number of simulations. Compare the
Monte-Carlo price with the Black-Scholes price.

2 VIX Calculation
Today’s date and time is February 19th 2016, 15:00:00. The interest rate is
r=0.0028. Download the option data provided in the Excel file “VIXdata.xlsx”, which
contain two worksheets:
• Worksheet “Short” contains options that expire on Mar 18 2016 at 15:00 (i.e.,
“near-term” options)

• Worksheet “Long” contains options that expire on Mar 25 2016 at 15:00 (i.e.,
“next-term” options)
Follow the step-by-step calculation in the document “vixwhite.pdf” and answer
the questions below.
a. What is the time to expiration of near-term options, T1 (in years)? What is
the time to expiration of next-term options, T2 (in years)? Note: a year has
525,600 minutes.

b. For both near- and next-term options, determine the forward SPX levels, F1
and F2 , by identifying the strike price at which the absolute difference between
call and put prices is smallest. Next, determine K0,1 and K0,2 (the strike prices
immediately below the forward index levels, F1 and F2 ) for the near- and next-
term options.

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c. Calculate the variance for both near- and next-term options, σ12 and σ22 .

d. Calculate the 30-day weighted average of σ12 and σ22 . Then take the square root
of that value and multiply by 100 to get the VIX value.

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