Question

2. (8 marks For this question, you may assume that interest rates are zero. Consider a butterfly position, constructed from a put options struck at $55, $60, and $65. The market prices are $3, $5, and $8, respectively. (a) Why would a trader buy this position? (b) Discuss whether the buyer of the position could be said to be long or short in the volatility of the underlying asset if the current value of the stock is $150.

Answer 1

part (e) - been bas been Construc Call opt Teen Buya b • seu to • Buys? Answes to Question past (a) In this Question a Bultenbly stoategy has Considered from a pot option, with a bith a stroke Price of $55, $60 and $65, who put premin are $3 & 5 and 88 respectively. . A tradea will Buy this position, when the trada to moderately Beaush about the market, The tradea will buy a put at a stule $65 Sell 2 put at a strike = $60 Buy 1 put at a stane $55 wherre D Tradea will form a Dobit put Butterfly Strategy, where it attain manimon profit when the spot price is approximately Canal to $60. part (f). Time paat (b) In the case of put Botteably shategy, The Buyear is slightly Beauch about the manuel Opnions and attain profit only when the machet is approxmately canal to $60. In the given scenario current value of the stocu has Rlsen to $150, which is against the marnet expectation of the trader, Therefore, we can say that volatility has Decreases the value of position hold by the tradee, and therefore he is said to be long Volatile. Esc

part (e) 7y has been with a stroke who put premio Constructing synthetic Butteelfly using Call option, forward contract and Zeero coupon Bonds. • Buya borw and contract seu two call option • Buy 1 Zeuo coupon Boud cely when the toodles, market, part (f). poolt and loss Diagram Time edule 65 the = $60 take $55 obit por Hain monimum approximately - Maximum pocut 15 achieves when stock parce is close to $60. $60 - ST (value of stock) $55 $65 Egy, The the macuet $601 ako st colich ou of the y has I by the be lona