Angus Beef Corp. currently trades at 100 in the market. Calls and puts on Angus Beef are
Question:
Angus Beef Corp. currently trades at 100 in the market. Calls and puts on Angus Beef are available with an exercise price of 104, The options expire in 240 days and the volatility is estimated as 0.4 (40% per year). Assume the continuous-time risk-free rate is 1% per year.
(a) Compute and explain the values of European call and put options using the BSM model. Assume there are no dividends for Angus Beef. Note that you would need to explain the components/numbers of the BSM formula in more details for the options of Angus Beef.
(b) As a put writer of Angus Beef, how could you construct a risk-free portfolio to protect your positions? Explain the practicality of such a continuous-time hedging against the fluctuations of Stock Angus Beef.
(c) Continue with (b). Now 40 days later, Angus Beef stock prices increase to 109, and the volatility is estimated to be 0.45. As a put writer, what would your actions be to protect your positions? Please explain the underlying reasons for your actions.