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The
The
The
The
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A special option expires in 6 months and will pay 0.3 times the price of the stock at that time, if it is
greater than 90. Otherwise it pays nothing.
Determine the price of the option.
Solution. We are given: S0 = 80, = 0.04, r = 0.02, = 0.2. We need to calculate the price of the
following special option:
0.3 S, S > 90
SO =
0,
S 90
The value of the asset-or-nothing call option S|S > K is S0 eT N (d1 ). Calculating, we obtain:
80
+ 0.02 0.04 + 0.5 0.22 0.5
ln 90
ln (S/K) + (r + 12 2 )t
0.1178
=
= 0.8329
=
d1 =
0.1414
t
0.2 0.5
N (d1 (90)) = N (0.83) = 0.2033
SO = e0.040.5 0.3 80 0.2033 = 4.7826
Problem 2
For a stock whose price at time t is S(t), you are given:
(i)
(ii)
(iii)
(iv)
S(0) = 60
The stocks price follows the Black-Scholes framework.
The stock pays continuous dividends proportionate to its price at a rate of 0.02.
The continuously compounded risk-free interest rate is 0.07.
An option will pay S(1) at the end of one year if S(1) > 80. Otherwise it will pay nothing. The price
of this option is 3.35. Determine the volatility of the stock.
Solution. We are given: S0 = 60, = 0.02, r = 0.07. We need to find . We are given the value of
the following special option:
S1 , S1 > 80
SO =
0, S1 80
The value of the asset-or-nothing call option S|S > K is S0 eT N (d1 ). Calculating, we obtain:
SO = 60e0.02 N (d1 (80)) = 58.8119N (d1 (80)) = 3.35
3.35
N (d1 (80)) =
= 0.05696 0.0571 d1 (80) = 1.58
58.8119
By definition of d1 :
ln 60
+ 0.07 0.02 + 0.5 2 1
ln (S/K) + (r + 12 2 )t
80
d1 =
=
= 1.58
t
1
0.2377 + 0.5 2
1.58 0.5 2 + 1.58 0.2377 = 0
Problem 4
You are given the following prices for a stock:
Date
Price
Apr. 1
57
Apr. 2
71
Apr. 3
63
Apr. 4
52
Problem 5
For a 3-month European gap call option on a stock:
(i) The stocks price is 37.
(ii) The strike price is 45.
(iii) The trigger is 35.
(iv) The stocks annual volatility is 25%.
(v) The stock pays continuous dividends proportional to its price at a rate of 0.03.
(vi) The continuously compounded risk-free interest rate is 0.07.
Determine the Black-Scholes option premium.
(A) 3.49
(B) 0.15
(C) 0.85
(D) 3.18
(E) 4.01
Key: A
Solution. In this problem K1 = 45 and K2 = 35.
C = Set N (d1 (K2 )) K1 ert N (d2 (K2 )), where
+ 0.07 0.03 + 0.5 0.252 0.25
ln 37
ln (S/K2 ) + (r + 0.5 2 )t
35
=
=
d1 (K2 ) =
0.25 0.5
t
0.0734
=
= 0.5871
0.125
N (d1 (K2 )) = N (0.5871) = 0.7214
(iv) The continuously compounded risk-free rate for U.S. dollars is 4%.
(v) The continuously compounded risk-free rate for Canadian dollars is 6%.
(vi) The relative volatility of Canadian dollars to U.S. dollars is 9%.
Determine the total value of such gap options.
(A) 1.18
(B) 1.02
(C) 2.95
(D) 4.88
(E) 5.35
Key: C
Solution. We are given: x0 = 0.95, K1 = 0.9, K2 = 1, rd = rU SD = r = 0.04, rf = rCD = 0.06 =
, = 0.09.
C = x0 erf t N (d1 (K2 )) K1 ert N (d2 (K2 )), where
ln 0.95
+ 0.04 0.06 + 0.5 0.092 1
ln (x0 /K2 ) + (r rf + 0.5 2 )t
1
d1 (K2 ) =
=
=
0.09 1
t
0.0672
=
= 0.7471
0.09
N (d1 (K2 )) = N (0.7471) = 0.2275
(B) 57.68
(C) 62.17
(D) 79.88
(E) 90.97
Key: A
Solution. We are given: T = 0.5, S0 = 70, K2 = 65, = 0.3, = 0.02, r = 0.05, r = 0.03.
P = K1 erT N (d2 (K2 )) SeT N (d1 (K2 )), where
2 0.5
ln 70
+
0.03
+
0.5
0.3
0.1116
ln (S/K2 ) + (r + 0.5 2 )t
= 65
=
= 0.5261
d1 (K2 ) =
0.2121
t
0.3 0.5
N (d1 (K2 )) = N (0.5261) = 0.2994
(I)
(B) 3.59
(C) 5.22
(D) 9.93
(E) 21.28
Key: A
Solution. The risk-free rate is irrelevant.
C = SeS T N (d1 ) QeQ T N (d2 ), where
ln (S/Q) + (Q S + 0.5 2 )T
, d2 = d1 T
d1 =
T
In our problem: S = S (II) , Q = 1.5 S (I)
The relative volatility is
1
1
1
2
= I2 + II
2 I II 2 = 0.452 + 0.252 2 0.7 0.45 0.25 2 = (0.1075) 2 = 0.3279
The Black-Scholes exchange option premium is:
C = S (II) eII T N (d1 ) 1.5 S (I) eI T N (d2 ), where
ln S (II) /1.5 S (I) + (I II + 0.5 2 )T
ln 65 + (0.04 0.07 + 0.5 0.1075) 1
d1 =
= 1.555
=
0.3278 1
T
0.2147
=
= 0.6547, N (d1 ) = N (0.6547) = 0.2563
0.3278
d2 = d1 T = 0.9826, N (d2 ) = N (0.9826) = 0.1629
C = 65 e0.071 0.2563 82.5e0.041 0.1629 = 15.5349 12.9128 = 2.6221 2.62
Answer A.
Problem 9
For a stock you are given:
(i) The stocks price is 98.
(ii) The stock pays continuous dividends proportionate to its price at a rate of 0.04.
(iii) The continuously compounded risk-free interest rate is 0.04.
An option allows you to choose, at the end of 9 months, between 105-strike European put and call
options expiring at the end of 12 months from now.
You are given the following prices for European call options with strike price 105:
Expiry
Option price
3 months
6.30
6 months
10.57
9 months
11.53
12 months
12.85
Page 5 of 7
Problem 10
For a nondividend paying stock, you are given:
(i) The stocks price is 70.
(ii) The stocks volatility is 30%.
(iii) The continuously compounded risk-free interest rate is 0.05.
An option allows you to choose, at the end of 3 months, between at-the-money (i.e. S=K) European
call and put options expiring at the end of 8 months from now.
Using the Black-Scholes framework, determine the value of this chooser option.
Solution. We are given: S0 = 70, = 0.3, t = 0.25, T =
8
12 ,
T t=
5
12 ,
r = 0.05, = 0.
V = C(S, K, T ) + e(T t) P S, Ke(r)(T t) , t
C(S, K, T ) = SeT N (d1 ) K1 erT N (d2 ), where
70
+ 0.05 + 0.5 0.32
ln 70
ln (S/K) + (r + 0.5 2 )T
q
d1 =
=
8
T
0.3 12
8
12
0.0633
= 0.2586
0.2449
N (d1 ) = N (0.26) = 0.6026
= 0.2972 0.3
d1 =
0.3 0.25
N (d1 ) = N (0.3) = 0.3821
Page 7 of 7