MSc 2010 Tutorial 4 Solution guidelines
Q1
This is about intrinsic value and time value.
March 1800 call is ‘deep in-the-money’, ie a large amount of intrinsic value
(226). There is only a small amount of time value (6), principally because of
the short time to expiration. The March 1800 put has zero intrinsic value and
there is very little chance of moving into the money in the next 42 days (S
needs to fall below 1800). Hence time value is only 3.
September options are worth more than March options with the same K
because of time value. Time to expiration is much longer (224 days) so there
is more opportunity for a large price change.
Q2
First find the value of the dividend from spot-futures parity.
I = S0 F0 erT
= 2026 2014.1e0.008 224/365)
= 21.76
Cost of PP = 2026 + 124.5 = 2150.5
Cost of SH = 2026 + zero cost of futures contract
i. ST = 1800
PP: exercise @ 2000 outcome 2000 2150.5 = 150.5
+ FV of Div 21.76e0.008 224/365 = 21.87
Net result = 128.63
SF: Convergence FT = ST = 1800
Gain on futures 2014.1 1800 = 214.1
Loss on share = 226
FV of Div = 21.87
Net result = +9.97
ii. ST = 2200
PP: do not exercise outcome 2200 2150.5 = 49.5
+ FV of Div = 21.87
Net result = 71.37
SF: Convergence FT = ST = 2200
losson futures 2014.1 22 00 = 185.9
gain on share = 174
FV of Div = 21.87
Net result = +9.97
**Discuss the different outcomes
Q3
