Question

(a) You are a derivatives trader. A salesperson comes to you with a strange request. An important customer wants to buy a derivative with the following property: it will make a single payout of $1000 whenever Google stock—which, you notice, is currently trading at $628.28—first trades at $1000. At what price would you do the trade, and why? (Assume that Google does not pay dividends. This is an important customer, so you should try to give as good a price as possible; but make sure that you do not risk losing money on the trade.)

(b) Later, a different client comes back wanting to do a somewhat similar trade. Now, though, the customer wants to buy a derivative that pays $1000 whenever Google stock first trades at $100. At what price would you do the trade, and why?

Answer 1

a) As in 1st example customer wants pay out whenever google stock come to $1000 it means he is a bull and expecting increase in the stock price so , being a broker of such client I would advise to buy a call option of price lower then $ 628.28 so customer won't lose when Google stock reaches to $1000 he can buy a stock again ge can also sell the put however in that case loss can be unlimited hence it's better to buy a call and put strict stop loss.

b) here customer is bear on google hence he can buy a put option around current market price with the strict stop loss , whenever price will move towards $100 from current price customer will make profit in the trade