A bank sells 1,000,000 European at-the-money calls on a share where the current share price is £50, the risk-free rate is 2.5%, the time to expiry is 3 months, and the standard deviation on the shares (σ) is 22.5%.

Required:

a)What is the theoretical monetary value of this transaction to the bank?

b)What position should the bank take in the share for delta neutrality?

c)Suppose that the bank does set up a delta neutral position as soon as the option has been sold and the share price falls to £45 within the first hour of trading. What trade is necessary to maintain delta neutrality?

d)Describe the difference between a ‘covered’ and a ‘naked’ position

e)What is the difference between a bull and a bear spread trading strategies?

Answer rating: 100% (QA)

Option Valuation and Hedging in BlackScholes Model Heres the breakdown of your questions a Monetary Value To calculate the theoretical monetary value ... View the full answer