Essay on Futures and Options Chapter 9 Answer

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Mechanics of Options Markets

Practice Questions

Problem 9.8.
A corporate treasurer is designing a hedging program involving foreign currency options. What are the pros and cons of using (a) the NASDAQ OMX and (b) the over-the-counter market for trading?

The NASDAQ OMX offers options with standard strike prices and times to maturity. Options in the over-the-counter market have the advantage that they can be tailored to meet the precise needs of the treasurer. Their disadvantage is that they expose the treasurer to some credit risk. Exchanges organize their trading so that there is virtually no credit risk.

Problem 9.9.
Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until
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Both options have the same maturity. The call costs $3 and the put costs $4. Draw a diagram showing the variation of the trader’s profit with the asset price.

Figure S9.4 shows the variation of the trader’s position with the asset price. We can divide the alternative asset prices into three ranges:
a) When the asset price less than $40, the put option provides a payoff of [pic] and the call option provides no payoff. The options cost $7 and so the total profit is [pic].
b) When the asset price is between $40 and $45, neither option provides a payoff. There is a net loss of $7.
c) When the asset price greater than $45, the call option provides a payoff of [pic] and the put option provides no payoff. Taking into account the $7 cost of the options, the total profit is [pic].
The trader makes a profit (ignoring the time value of money) if the stock price is less than $33 or greater than $52. This type of trading strategy is known as a strangle and is discussed in Chapter 11.


Figure S9.4 Profit from trading strategy in Problem 9.12

Problem 9.13.
Explain why an American option is always worth at least as much as a European option on the same asset with the same strike price and exercise date.

The holder of an American option has all the same rights as the holder of a European option and more. It must therefore be worth at least as much. If it were not, an arbitrageur could short the

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