Attempt all problems If you need to make an assumption to complete a calculation be explicit about what it is Q2) (10 Points) Two different European GE call options are available in the market. Option A has an exercise price of $95, trades at an implied annual volatility of 30% and costs $3.7521 per call. Option B has a strike rate of $85, trades at an implied annual volatility of 20% and costs $7.2748 per call. Both options are based on the same stock which is currently trading at $90 and pays no dividends. The annual risk free rate is 5%. Both option prices are right in line with a Black-Scholes valuation. Assume continuous compounding. a) You believe that all GE call option volatility is going to converge to 25% in the short term. Given this set up a delta neutral strategy using these two options to take advantage of the convergence. Assume you want to trade 1,000 Option A calls. b) Estimate the profit if the convergence happens immediately and the stock price stays at $90. c) What is the profit if the stock moves to $89 or to $91? How well is the hedge performing. Attempt all problems If you need to make an assumption to complete a calculation be explicit about what it is Q2) (10 Points) Two different European GE call options are available in the market. Option A has an exercise price of $95, trades at an implied annual volatility of 30% and costs $3.7521 per call. Option B has a strike rate of $85, trades at an implied annual volatility of 20% and costs $7.2748 per call. Both options are based on the same stock which is currently trading at $90 and pays no dividends. The annual risk free rate is 5%. Both option prices are right in line with a Black-Scholes valuation. Assume continuous compounding. a) You believe that all GE call option volatility is going to converge to 25% in the short term. Given this set up a delta neutral strategy using these two options to take advantage of the convergence. Assume you want to trade 1,000 Option A calls. b) Estimate the profit if the convergence happens immediately and the stock price stays at $90. c) What is the profit if the stock moves to $89 or to $91? How well is the hedge performing