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Problem set 3 (chapter 10) answers

The document contains problem sets related to European options, detailing the conditions for profit and exercise for both put and call options. It includes calculations for various scenarios involving stock prices, strike prices, and option costs. Additionally, it discusses the effects of corporate actions like stock dividends and splits on option contracts.

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jash.shahug25
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5 views

Problem set 3 (chapter 10) answers

The document contains problem sets related to European options, detailing the conditions for profit and exercise for both put and call options. It includes calculations for various scenarios involving stock prices, strike prices, and option costs. Additionally, it discusses the effects of corporate actions like stock dividends and splits on option contracts.

Uploaded by

jash.shahug25
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Problem Set 3 (Chapter 10)

Nisanka Khataniar

06/03/2025

Problem 10.11
Given:
• European put option price: $3
• Stock price: $42

• Strike price: $40


The payoff of a put option at expiration is given by:

P = max(K − ST , 0) − C (1)

where:
• K = 40 (strike price)
• ST is the stock price at expiration
• C = 3 (cost of option)

The investor makes a profit if:

max(40 − ST , 0) > 3 (2)

which implies:
40 − ST > 3 ⇒ ST < 37 (3)
Thus, the investor profits if the stock price falls below $37.
The option is exercised if:
ST < 40 (4)

1
Problem 10.12
Given:
• European call option sold for $4
• Stock price: $47

• Strike price: $50


The profit for the seller of the call option is:

P = C − max(ST − K, 0) (5)

where C = 4, K = 50.
The investor makes a profit if:

4 − max(ST − 50, 0) > 0 (6)

which implies:
ST < 54 (7)
Thus, the investor profits if the stock price remains below $54.
The option is exercised if:
ST > 50 (8)

Problem 10.16
Given:

• European call option price: $5


• Strike price: $100
The profit for the holder of the call option is:

P = max(ST − 100, 0) − 5 (9)

For profit:
ST − 100 > 5 ⇒ ST > 105 (10)
Thus, the holder makes a profit if the stock price exceeds $105.
The option is exercised if:
ST > 100 (11)

2
Problem 10.17
Given:
• European put option price: $8
• Strike price: $60

The profit for the seller (writer) of the put option is:

P = 8 − max(60 − ST , 0) (12)

For profit:
8 > 60 − ST ⇒ ST > 52 (13)
Thus, the seller makes a profit if the stock price remains above $52.
The option is exercised if:
ST < 60 (14)

Problem 10.19
Given:

• Call option: Strike $45, Cost $3


• Put option: Strike $40, Cost $4
Total cost: $7.
The net payoff depends on ST :

• If ST < 40: Put option exercised, payoff 40 − ST − 7


• If 40 ≤ ST ≤ 45: Both options expire worthless, loss = -7

• If ST > 45: Call option exercised, payoff ST − 45 − 7

Problem 10.23
Effect of corporate actions on the option contract:

• 10% Stock Dividend: The strike price is adjusted downwards, and the
number of shares per contract increases.

• 10% Cash Dividend: No direct effect on option terms (only affects stock
price).
• 4-for-1 Stock Split: Strike price is divided by 4, and the number of
shares per contract is multiplied by 4.

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