Question 4: Trading Strategies Involving Options (12 marks) By combining two short puts at a middle...

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Question 4: Trading Strategies Involving Options (12 marks) By combining two short puts at a middle strike K2, and one long put each at a lower K₁ and upper K3 strike, one creates a long put butterfly spread. All options have the same expiry date. Consider a butterfly spread using European put options for a non- dividend paying stock, where the following information is given: • The current stock price is $20, • The put option with strike price K1= 15, • The put option with strike price K2= 20 and •The put option with strike price K3 = 25, •The interest rate is 2% p.a. continuously compounded, • Annual volatility is 30% and • The time to maturity for all options is 6 months. Required a) Calculate the price of the above butterfly spread. The calculate the price of a butterfly spread created with call options with strikes K1= 15, K2= 20 and K3= 25, respectively. Which of those two butterfly spreads is more expensive? (4 marks) b) Construct tables presenting the profit and payoff for the inversed butterfly spread created from the above described put options. Discuss the best scenario in terms of payoff for an investor who buys the inversed butterfly spread. (4 marks) c) Consider a situation in which an investor has sold a butterfly spread created with puts. What action should be taken to make his combine position delta neutral? (4 marks) Question 4: Trading Strategies Involving Options (12 marks) By combining two short puts at a middle strike K2, and one long put each at a lower K₁ and upper K3 strike, one creates a long put butterfly spread. All options have the same expiry date. Consider a butterfly spread using European put options for a non- dividend paying stock, where the following information is given: • The current stock price is $20, • The put option with strike price K1= 15, • The put option with strike price K2= 20 and •The put option with strike price K3 = 25, •The interest rate is 2% p.a. continuously compounded, • Annual volatility is 30% and • The time to maturity for all options is 6 months. Required a) Calculate the price of the above butterfly spread. The calculate the price of a butterfly spread created with call options with strikes K1= 15, K2= 20 and K3= 25, respectively. Which of those two butterfly spreads is more expensive? (4 marks) b) Construct tables presenting the profit and payoff for the inversed butterfly spread created from the above described put options. Discuss the best scenario in terms of payoff for an investor who buys the inversed butterfly spread. (4 marks) c) Consider a situation in which an investor has sold a butterfly spread created with puts. What action should be taken to make his combine position delta neutral? (4 marks)

Answer rating: 100% (QA)

a To calculate the price of the butterfly spread we first need to find the individual prices of the put options using the BlackScholes formula For a p... View the full answer