 # Derivatives Quickie Questions

Having trouble with these, please see if you can explain. Then again, I read derivatives last night so I might not have retained as much as I thought: 1. The current price of an asset is 100. An out-of-the-money American put option with an exercise price of 90 is purchased along with the asset. If the breakeven point for this hedge is at an asset price of 114 at expiration, then the value of the American put at the value of purchase must have been: A. 0 B. 4 C. 10 D. 14 2. A silver futures contract requires the seller to deliver \$5,000 Troy ounces of silver. An investor sells one July silver futures contract at a price of \$8 per ounce, posting a \$2,025 initial margin. If the required maintenance margin is \$1,500, the price per ounce at which the investor would first receive a maintenance margin call is closest to: A. \$5.92 B. \$7.89 C. \$8.11 D. \$10.80 Answers to be posted after a few responses. Thanks!!

D C

1. The current price of an asset is 100. An out-of-the-money American put option with an exercise price of 90 is purchased along with the asset. If the breakeven point for this hedge is at an asset price of 114 at expiration, then the value of the American put at the value of purchase must have been: A. 0 B. 4 C. 10 D. 14 It is out of the money at X=90. X = 114 X - S = 0 at Breakeven – and S0 = 100 So Price of Put = X - S = 14 Choice D 2. A silver futures contract requires the seller to deliver \$5,000 Troy ounces of silver. An investor sells one July silver futures contract at a price of \$8 per ounce, posting a \$2,025 initial margin. If the required maintenance margin is \$1,500, the price per ounce at which the investor would first receive a maintenance margin call is closest to: A. \$5.92 B. \$7.89 C. \$8.11 D. 10.80 (2025 - 1500 ) = 525 525 / (5000 ) = 0.105 price change. Since he is selling - he’ll get a margin call when his price rises. So Maintenance margin call will be got at 8 + .105 = 8.11 \$ Choice C
1. D 2. C

Answers are D and C — thanks for the help cpk! Could you explain this a little more though? Isn’t the strike price of the put 90? Why wouldn’t it be 90-100 = -10 which is 0 since you can’t have negative value??? That is what’s confusing me… Also, if the SP rises, wouldn’t the put be useless?

At X=90 it says it is an Out of the money put. But the key thing is that they want the value of put when X = 114… which is what we are being asked.

I haven’t been using any formulas to answer option questions. I’ve just been trying to think about it logically. In this case you own the stock and a put option. The breakeven is \$114. Since you’ve gained \$14 on the stock, the put premium must be \$14.

I don’t know if I get it still…I may have to re-read the section. But thanks guys. I think I get put/calls in theory, but the problems have always thrown me off a little.

I agree with Moto376 that you shouldn’t use formulas to answer this question. I was an options market maker on the CBOE floor for a dozen years and the way I would think about it is simple–you buy the stock and the put and break even when stock moves to your total cost. 100 + put = 114, put = 14. And the flip side of the question might be how much can you lose…you paid 100 plus 14, and if the stock drops far enough you are stopped at 90 (the put strike) so the most you can lose is 24 (14 bucks for the put plus the difference between 100 purchase and 90 sale.) Another way I look at it is being long stock and long a put is like being synthetically long a call…in this case being long the 90 call for 24 dollars. Look at the payout in the two scenerios (being long the 90 call for 24, or, owning stock for 100 and the 90 put for 14) excluding divs and interest the payout is the same. This probably won’t be tested, but it might help in understanding options. Put call parity is certainly testable, and understanding synthetic relationships is simply rearranging the equation. Hope it helps.

I think they should have asked for the premium paid for the put option and the value of the option… It would have been more straghtforward .

I don’t think straightforward was the goal…