Question

help on both questions plz

Extra #8 Is there any option that is priced wrongly? KNJ expiration Aug Nov Aug Nov Current underlying stock price: $32 Strike Call Put 7.80 0.05 6.60 0.10 4.60 0.70 5.10 25 0.10 35 35 A. Aug 25 Call B. Aug 25 Put C. Aug 35 Call D. Aug 35 Put E. None of them #22 Suppose you sold one contract of Corn futures at $4 per bushel (5,000 bushels per contract). The futures prices in the next four days were $4.01, $3.98, $3.99 and $4.02. What is your mark-to-market sequence of cash flow per bushel?

Answer 1

#8

Let us find the Intrinsic Value of each option.

An option will be priced incorrectly, if its current value is lower than the Intrinsic Value or the pay-off obtained by exercising the option immediately.

Aug 25 call :-

Intrinsic Value of Call Option is Max {0, (Stock Price - Strike Price)}

Current Stock Price = 32

Strike Price = 25

Hence, Intrinsic Value of Call Option is Max {0, (Stock Price - Strike Price)} = Max {0, (32-25)} = 7

Price of call = 7.8

Since, Actual Price > Intrinsic Value, it is valued correctly

Aug 25 Put :-

Intrinsic Value of Put Option is Max {0, (Strike Price - Stock Price)}

Hence, Intrinsic Value of Put Option = Max {0, ( 25 - 32)} =0

Price of Put Option = 0.05

Since, Actual Price > Intrinsic Value, it is valued correctly

Aug 35 Call :-

Intrinsic Value of Call Option is Max {0, (Stock Price - Strike Price)}

Current Stock Price = 32

Strike Price = 35

Intrinsic Value = Max {0, (32-35)} = 0

Price of Call Option = 0.10

Since, Actual Price > Intrinsic Value, it is valued correctly

Aug 35 Put :-

Intrinsic Value of Put Option is Max {0, (Strike Price - Stock Price)}

Hence, Intrinsic Value of Put Option = Max{0, (35-32)} = 3

Current price = 4.6

Since, Actual Price > Intrinsic Value, it is valued correctly

Since, all options are valued correctly, Answer will be Option E