Reference no: EM132432906

Options

Question 1: Your broker has suggested a new strategy for you. The strategy consists of:

-Writing a call option

-Buying a put option on the same stock with the same strike price

-Holding the stock that underlies both options

Your broker believes that the proceeds from writing the call option will more than cover the cost of the put option given current market prices. In addition, since buying the put is similar to buying insurance on the stock, he suggests that you are eectively getting the call buyer to nance the cost of the insurance.

Examine the payo of the combined position above. What do you think of the strategy?

Question 2: Traptor stock is currently trading for $7.12. There are puts and calls traded on Traptor. In particular, you know that a call option with a strike of $6.75 which matures one year from today is trading in the market for $1.39. The risk-free rate is 3% (in annual terms).

What should the put trade at if there are no arbitrage opportunities? You may assume that Traptor pays no dividends over the next year.

Question 3: Consider otherwise identical (in terms of strike price, maturity, underlying asset, etc.) European puts and calls on a non-dividend paying asset. What determines whether the call will be worth more than the put? Hint: use the put-call parity condition to arrive at a mathematical condition where the strike price is the key variable.