Reference no: EM13828107

Problem:

Consider that on a recent day, Wal Mart Stock closed at $55.19 per share, down by $0.05 on the day. In the questions that follow, use the "Last Sale" column to answer questions which involve option pricing.

1. a. What was the premium on the '13 Sept. WMT 47.50 call, i.e., the Wal Mart call which expires in Sept. 2013 and has a strike price of $47.50?

b. How much would an investor who wanted to buy 1 contract of the '13 Sept. WMT 47.50 call option have had to spend?

c. What is the formula for the intrinsic value of a call?  What was the intrinsic value of the '13 Aug. WMT 50 call?  Was this option "in the money" or "out of the money"?  What was the time value of this option?

d. Was the '13 Sept. WMT 60 call in or out of the money?  What was the intrinsic value of this option?  What was the time value of this option?

e. What was the premium on the '13 Sept. WMT 60 put?  Was this option in or out of the money?  What was the intrinsic value of this put?  What is the time value?

f. What was the intrinsic value of the '13 Aug. WMT 50 put?  Was this option in or out of the money?  What was the option's time value?

2. On a recent day, Microsoft stock (symbol:  MSFT) was at $25.  Assume the nearby MSFT 25 call was selling for $1.  Draw a hockey stick diagram for a long position in the MSFT 25 call.

3. a. If the MSFT 24 call is selling for $2.50, and the MSFT 25 call is selling for $1, construct a bull spread using these calls.

b. Construct a table like the ones we did in class showing profit and loss at relevant stock prices for each part of the spread, and the net profit or loss for the entire spread position. Draw a hockey stick diagram for the spread, clearly labeling all the critical points.

4.  Consider a "long strangle" constructed from options which have an expiration date of August 16, 2013 (the third Friday in August).  The following table displays the possible prices of Boeing stock on August 16, as well as the payoffs accruing to someone who holds a long strangle on Boeing stock: 

    Probability                          0.2      0.3       0.2        0.2       0.1

    Stock price                         $80     $90     $100     $110     $120

    Gain from long strangle       $15       $5        $0        $10      $20

A long strangle is created using two options.  For each option in the strangle above, indicate whether it is a put or a call, whether it is bought or sold, and calculate what its strike price is.  Explain your answer.

Please find Wal Mart Stores data in the PDF document attached.

Additional Information:

This question is from increasing as well as decreasing derivatives. Various features of derivatives such as stock price, strike price, call options, put options, the intrinsic value, etc have all been stated in the solution with proper computations.