Charles Mabry manages a portfolio of equity investments heavily concentrated in biotech industry. He is currently long on BIC. Several regulatory agencies criticized the rigor of BIC’s product testing. In an effort to manage the risk associated with BIC, Mabry has decided to allocate some portion of portfolio to options on BIC common stock. After surveying the derivatives market, Mabry has identified following European options on BIC. BIC Call options: Option | strike | Maturity | Premium Call A 40 October 3.51 Call B 50 October 1.98 Call C 60 October 1.42 BIC Put options: Option | strike | Maturity | Premium Put D 30 October 2.31 Put E 40 October 4.14 Put F 50 October 9.21 BIC’s stock closed on June, 1 (yest) at $42. Mabry expects BIC equity to make a recovery despite of the intense market scrutiny but wants to provide hedge against negative earnings surprise. He consults with Grimmel (derivatives expert) and Grimmel makes following two statements: Statement 1: If you want to avoid selling BIC position and are willing to earn risk free rate, you should sell calls and buy puts on BIC stock with the same Premium. Alternatively you could buy put options to manage the risk of the portfolio. Statement 2: I recommend waiting until vega on the options rises, making them less attractive and cheaper to purchase. 49) Which of the following statements regarding delta of BIC options is correct ? A. Call C has the highest delta of all BIC options B. Put D has smallest delta of all BIC options. C. Put F has largest delta of all BIC options. 50) If gamma of Put E is equal to 0.081, which of the following correctly interprets the option’s gamma ? A. The sensitivity of put E’s price to changes in BIC 's stock price is very likely to change. B. A dynamic hedge strategy using put E would require infrequent balancing. C. A $1.00 increase in BIC’s stock price, will increase Put E’s premium by $0.081. 54)Which of the following correctly analyzes the comments made by Grimmel ? A. Only Grimmel’s statement regarding earning risk free rate is correct. B. Only Statement regarding Vega to rise is correct. C. Neither is correct.
49 C) Put F has the largest delta. Since it has the biggest premium among all the choices F=9.21, D=2.31, C=1.42 --> shows that it is furthest in the money 50. Gamma = change in delta / change in underlying price so based on the fact that there is a gamma - choice B is wrong - a dynamic hedge using put E will require FREQUENT rebalancing. I am inclined to go here with A) sensitivity of put E’s price to BIC’s stock price is very likely to change. -> I think this is what Gamma means.
C C C
nobody seems to be interested in derivatives today…even SWG ? Anyway CP nice. You got both of them correct. Some learnings: For first, look at the premium to find out “how much in the money” the option is. I unnecessarily wasted time comparing yesterday’s closing price and the strike price for call/put options. Furthest in the money has highest delta… C is correct. Second one- I was little confused by the absolute value of gamma. 0.084 per say does not indicate to me high or low… those who practically trade in derivatives can provide insight. Higher gamma means higher need to rebalance. But there is no other information available. So just the existence of gamma itself indicates need to rebalance. A is correct. Third one - READ CLOSELY. If vega rises, the volatility is more and the options become more costly not cheap. So second statement is incorrect. “If you want to avoid selling BIC position and are willing to earn risk free rate, you should sell calls and buy puts on BIC stock with the same Premium” This would be valid based on put call parity for same STRIKE PRICE, not the same premium. I did not read it closely enough… C is correct.
charu_mulye Wrote: ------------------------------------------------------- > nobody seems to be interested in derivatives > today…even SWG ? Got stuck up with work.
question 49’s choices are poorly worded - it uses largest, smallest, and highest in each of the choices. Technically, Put F has the SMALLEST delta (closer to -1), so using “largest” is a bit misleading.
mp2438 Wrote: ------------------------------------------------------- > question 49’s choices are poorly worded - it uses > largest, smallest, and highest in each of the > choices. Technically, Put F has the SMALLEST delta > (closer to -1), so using “largest” is a bit > misleading. mp2438, Question said highest absolute value or something like that. I forgot to post it there. As the question is posted here, you are correct. Hoever, -1, +1 is only the convention in theory. Even the softwares (option calculators) calculate absolute delta value, if I’hv not mistaken.
yes charu is correct
Got 1/3. Have to agree with mp2438. When I drew the line from -1 --0—+1. The Put F is more towards the -1, so it has the **least abscissa**. [Poor wording]
Makes sense.
charu_mulye Wrote: ------------------------------------------------------- > This would be valid based on put call parity for > same STRIKE PRICE, not the same premium. > I did not read it closely enough… > > C is correct. Also wouldn’t you have to sell and/or purchase a combination of bonds and/or the underlying asset based on put call parity? The buying and selling of call and put options is insufficient.
> Also wouldn’t you have to sell and/or purchase a > combination of bonds and/or the underlying asset > based on put call parity? The buying and selling > of call and put options is insufficient. You are already long the stock in this example.
3/3. GO ALI!
McHigi Wrote: ------------------------------------------------------- > > Also wouldn’t you have to sell and/or purchase > a > > combination of bonds and/or the underlying > asset > > based on put call parity? The buying and > selling > > of call and put options is insufficient. > > > You are already long the stock in this example. Oh I see. Thanks.
1/3 for me. So much to review - so little time.
swaptiongamma Wrote: ------------------------------------------------------- > > Got stuck up with work. What? work? - I guess some of us are lucky to have to worry about that too.
Adding on this the original posting, I have a question about #53 Given Mabry’s assessment of the risks associated with BIC, which option strategy would be most effective in hedging the risk of BIC stock? A. Add put options to the portfolio as the option delta moves closer to zero. B. Add call options to the portfolio as the option delta moves further away from zero. C. Add put options to the portfolio as the option delta moves further away from zero. Clearly, we need to add put options to hedge downside risk of BIC. Since the delta hedge ratio is the number of shares divided by the number of options, I picked “A”, as delta gets closer to zero, number of options should increase. The solution says “C” with the following explanation: Because the delta of the put option is negative, as the option delta moves away from zero (ie, closer to -1), the option becomes more in the money, and the number of options necessary to maintain the hedge will decrease. However, looking at the solution, it is equivalent to “as the option delta moves towards zero”, the option becomes more out of the money, and the number of options necessary to maintain the hedge will increase". This points to Choice “A”. any thoughts?