Deck 1: Introduction

Question 1

A trader sells 100 European put options i.e. one contract) with a strike price of $50 and a time to maturity of six months. The price received for each option is $4. The price of the underlying asset is $41 in six months. What is the trader's gain or loss? Show a dollar amount and indicate whether it is a gain or a loss. _ _ _ _ _ _ _ _ _ _

Answer 1

$500 loss

Question 2

Compare the differences between hedging using forward contracts and hedging using options.

Answer 2

Forward contracts help hedger to mitigate risk of adverse price movement by fixing the purchase price or the sale price for the underlying asset. On the contrary, options protect hedger from the downside risk while still provides an opportunity to gain from favourable price movements. Besides, it costs nothing to enter into a forward contract, whereas option requires an up-front fee.

Question 3

A trader buys 100 European call options i.e. one contract) with a strike price of $20 and a time to maturity of one year. The cost of each option is $2. The price of the underlying asset proves to be $25 in one year. What is the trader's gain or loss? Show a dollar amount and indicate whether it is a gain or a loss. _ _ _ _ _ _ _ _ _ _

Answer 3

$300 gain

Question 4

Which of the following is not true? choose one)

A) When an ASX call option on BHP is exercised, BHP issues more stock.
B) An American option can be exercised at any time during its life.
C) A European call option will always be exercised at maturity if the underlying asset price is greater than the strike price.
D) A European put option will always be exercised at maturity if the strike price is greater than the underlying asset price.

Question 5

A trader enters into a one-year short forward contract to sell an asset for $60 when the spot price is $58. The spot price in one year proves to be $63. What is the trader's gain or loss? Show a dollar amount and indicate whether it is a gain or a loss. _ _ _ _ _ _ _ _ _ _

Question 6

A one-year call option on a stock with a strike price of $30 costs $3. A one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option.
i) What is the breakeven stock price, above which the trader makes a profit?
_ _ _ _ _ _
ii) What is the breakeven stock price, below which the trader makes a profit?
_ _ _ _ _ _

Question 7

The price of a stock is $36 and the price of a three-month call option on the stock, with a strike price of $36, is $3.60. Suppose a trader has $3600 to invest and is trying to choose between buying 1000 options and 100 shares of stock. How high does the stock price have to rise for an investment in options to lead to the same profit as an investment in the stock? _ _ _ _ _ _

Question 8

List three types of traders in futures, forward and options markets
i. _ _ _ _ _ _ _ _
ii. _ _ _ _ _ _ _ _
iii. _ _ _ _ _ _ _ _