Exam 18: Option Valuation and Strategies Private

If an investor sells a stock short, that individualreduces the risk of loss by

According to the Black/Scholes option valuationmodel, the value of a call option increases if

Bull and Bear spreads require taking a long position in one option and a short position in another option with a different strike price.

According to the Black/Scholes option valuationmodel, a call option's value decreases if

Put-call parity asserts that a combination of a long position in the stock and the put produces the same return as a comparable position in a call and a risk-free bond. If not, at least one market is in disequilibrium. The resulting arbitrage alters the securities' prices until the value of the stock plus the put equals the prices of the call and the bond. The successful use of arbitrage assumes the investor of a profit no matter what happens to the price of the stock.Put-call parity also asserts that if an arbitrage opportunity does not exist, then a combination of the stock and the put produces the same return as the comparable position in the call and the risk-free bond. Currently, the price of a stock is $70 while the price of a call option at $70 is $6; the price of the put option at $70 is $2, and the price of a discounted bond is $66. Verify that a long position in the stock and the put produces the same performance as a long position in the call and the bond for the following prices of the stock: $60, 65, 70, 75, and 80.SOLUTIONS TO PROBLEMS

The investor owns 1,000 shares of stock but anticipates its price may decline. To reduce the risk of loss, how many call options must be sold if the hedge ratio is 0.7

If the investor buys a bull spread, the individualanticipates

An investor buys a straddle in anticipation of stablestock prices.

If a stock is selling for $33 and you expect the price not to fluctuate, what are the potential profits and losses from writing a straddle if a call option at $35 sells for $3 and the put option at $35 sells for $4

If the investor buys a bear spread, the individualanticipates

The protective call strategy is an illustration of ashort position.

To construct a bear spread, the investor buys a call option and shorts the stock.

Put-call parity suggests that the sum of the prices of a stock, a call and a put on that stock, and a debt instrument maturing at the expiration of the options must equal zero.

An investor cannot buy and sell two different call options with the same expiration dates.

The hedge ratio indicates the number of call options that is necessary to offset price movements in the underlying stock.

The Black/Scholes option valuation model divides theoption's strike price by the probability that the option will be exercised.

If the investor anticipates that the price of stockwill be stable, he or she may

If the investor anticipates that the price of astock will fluctuate, this individual may

A call option is the right to buy stock at $25 a share. According to the Black/Scholes option valuation model, what is the value of the call a. if the price of the stock is $25, the interest rate is 8 percent, the option expires in three months, and the standard deviation of the stock's return is 0.20 (20 percent)? b. if the price of the stock is $25, the interest rate is 6 percent, the option expires in three months, and the standard deviation of the stock's return is 0.20 (20 percent)? c. if the price of the stock is $27, the interest rate is 8 percent, the option expires in three months, and the standard deviation of the stock's return is 0.20 (20 percent)?

According to the Black/Scholes option valuation model, the value of a call option rises as interest rates increase.