BEE3032 Tutorial 1

Introduction to Derivatives and Basic Trading Strategies

1. Suppose you short-sale 300 shares of XYZ stock at 30.19 with a commission charge of 0.5%.
Supposing you pay commission charges for purchasing the security to cover short sale, how
much prot have you made if you close the short sale at a price 29.87?
2. Suppose you desire to short sell 400 shares of JKL stock, which has a bid price of $25.12
and an ask price of $25.31. You cover the short position 180 days later when the bid price is
$22.87 and the ask price is $23.06.
(a) Taking into account only the bid and ask prices (ignoring commissions and interests),
what prot did you earn?
(b) Suppose that there is 0.3% commission to engage in the short sale (this is the commission to sell the stock) and a 0.3% commission to close the short sale (the commission
to buy the stock back) How do these commissions change the prot in the previous
answer?
(c) Suppose the 6-month interest rate is 3% and that you paid nothing on short sale proceeds. How much do you lose during the 6 months in which you have the short position?
3. Suppose the stock price is $40 and the eective annual interest rate is 8%.
(a) Draw on a single graph payo and prot diagrams for the following options:
i. 35-strike call with a premium of $9.123.
ii. 40-strike call with a premium of $6.22.
iii. 45-strike call with a premium of $4.08.
(b) Consider your payo diagram with all three options graphed together. Intuitively , why
should the option premium decrease with the strike price?
4. Suppose you enter into a long 6-month forward position at a forward price of $50.
(a) What is the payo in 6 months for prices of $40, $45, $50, $55, and $60?
(b) Suppose you buy a 6-month call option with a strike price of $50. What is the payo
in 6 months at the same prices for the underlying asset?
(c) Comparing payos of parts a) and b), which contract should be more expensive (the
long call or long forward)? Why?
5. Suppose XYZ stock pays no dividends and has a current price of 50. The forward price for
delivery in one year is 55. Suppose the 1 one year eective annual interest rate is 10%.
(a) Graph the payo and prot diagrams for a forward contract on a XYZ stock with a
forward price of 55.
(b) Is there any advantage to investing in the stock or the forward contract? Why?

(c) Suppose XYZ paid a dividend of 2 per year and everything else stayed the same. Now
is there any advantage in the stock or the forward contract? Why?

For the following problems assume the eective 6-month interest rate is 2%, the S&R
6-month forward price is $1020, and use these premiums for S&R options with 6 months
to expirations:
Strike
950
1000
1020
1050
1107

Call
120.405
93.809
84.470
71.802
51.873

Put
51.777
74.201
84.470
101.214
137.167

6. Suppose you buy the S&R index for $1000 and buy a 950-strike put. Construct payo and
prot diagram for this position. Verify that you obtain the same payo and prot diagrams
for this position by investing $931.37 in zero-coupon bond and buying a 950-strike call.
7. Verify that you earn the same prot and payo by
(a) buying the S&R index for $1000 and
(b) buying a 950-strike S&R call, selling a 950-strike S&R put, and lending $931.37.
8. Suppose the premium on 6-month S&R call is $109.20 and the premium on the put with
same strike price is $60.18. What is the strike price?
9. Construct payo and prot diagrams for the purchase of a 950-strike S&R call and sale of a
1000-strike call. Verify that you can obtain exactly the same prot diagram for the purchase
of 950-strike S&R put and sale of 1000-strike S&R put. What is the dierence in the payo
diagrams for the call an put spreads? Why is there a dierence?