Assume all rates are per annum continuously compounded
Consider the following three European call options, all expiring in one year. Option A has strike $17.00 and premium $7.00; Option B has strike $22.00 and premium $4.00; Option C has strike $27.00 and premium $2.00. Suppose the price on the stock today is $22.00.
(a) Which call(s) is(are) in-the-money?
A. Option A
B. Option B
C. Option C
D. None of the above
(b) Which call(s) is(are) out-of-the-money?
A. Option A
B. Option B
C. Option C
D. None of the above
(c) Suppose the risk-free rate is 4.7%. What is the maximum possible profit of the butterfly?
a. If the Strike price of an option is less than the Spot price of underlying security, then that option is in the money option.
Option A is correct. (Option with strike price of $17)
b. If the Strike price of an option is more than the Spot price of underlying security, then that option is out of the money option.
Option C is correct (Option with strike price of $27)
c) Butterfly with call option can be done by selling 2 call option of strike price $22 and buying one call option of strike price $17 and $27 each
Maximum Payoff happens when spot price expires at $22
Cash inflow or Outflow at beginning of the year = Premium Received by selling option- Premium paid by buying call option
=2*4-7-2=-$1
At the end of the year Call Option of strike price $27 and $22 will expire
Option payoff from option with strike price $17= 22-17=5
EAR= e^(4.7%.1)-1=4.81% (As Interest rate is continuously compounding)
Future Value of maximum profit=-1*(1+4.81%)+5=$3.95
Assume all rates are per annum continuously compounded Consider the following three European call options, all...
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