# Option - Questions

Please Explain with Calculation 1. A market participant has a view regarding the potential movement of a stock. He sells a customized over-the-counter put option on the stock when the stock is trading at \$38. The put has an exercise price of \$36 and the put seller receives \$2.25 in premium. The price of the stock is \$35 at expiration. The profit or loss for the put seller at expiration is: A. (\$1.25). B. \$1.00. C. \$1.25. D. \$2.25. I think the answer is “A” since he sells a put options, he wants price to go UP. So definitely a loss to him. A is the only choice …but in solution in says “C” 2. An investor purchases a stock at \$60 and at the same time, sells a 3-month call on the stock. The short call has a strike price of \$65 and a premium of \$3.60. The risk-free rate is 4%. The breakeven underlying stock price at expiration is closest to: A. \$55.85. B. \$56.40. C. \$60.80. D. \$61.40. 3. If market interest rates rise, the price of a callable bond, compared to an otherwise identical option-free bond, will most likely: Select exactly 1 answer(s) from the following: A. increase by less than the option-free bond. B. decrease by less than the option-free bond. C. decrease by more than the option-free bond. D. decrease by the same amount as the option-free bond. 4. All else equal, an increase in expected yield volatility is most likely to result in an increase in the price of a(n): A. putable bond. B. callable bond. C. option-free bond selling at a discount to par. D. option-free bond selling at a premium to par.

i got: C B D A

4 is A, almost sure

strike that, Q1 should be A

hang on, put SELLER not BUYER profits, so yes C is right

i think 3 is B

2 is B Breakeven on a cov call is S - P boom

when interest rates increase, it decreases the liklihood of the issuer wanting to call the bonds because they will have to reissue at a higher rates. thus convexity is positive and they behave the same as an option free bond…i think

for first question, X=36, S=35 ==> loss to put writer = X-S=1, but he gets 2.25 premium too==> net gain=1.25… I also marked A in the exam (dont knw why ?)

stokey99 Wrote: ------------------------------------------------------- > when interest rates increase, it decreases the > liklihood of the issuer wanting to call the bonds > because they will have to reissue at a higher > rates. thus convexity is positive and they behave > the same as an option free bond…i think yeah,m sounds right. so that means when rates rise, it decrease the bond more or less than a straight bond ?

in the second question whats the use of Risk free rate. The premium received could have been reinvested at risk free rate for 3-months ==> break even price lower than So-P . any thoughts ??

yes, should follow same path in a rising rate environment. when rates drop, the more they drop the higher the option free bond price will rise relative the the callable bond price which will flatten out around the call price

someone PLEASE post the CORRECT answers… i think we will maximize our time the more problems we do : )

I get C B (slightly less than 56.4 but close) B or D A

why slightly less than 56.40 for #2?? (reinvestment @ RFR)… ans for 2 is 56.40

because you can reinvest the premium @ RFR

I think 3 D, cause looking at the convexity of a callable bond, it has the exact same convexity as YTM increases, but when YTM decreases, its convexity inverts. am I right or what?

For 3, I’d say B. It decreases less than option free bond, because no matter what, option still has some worth, despite being further out of money.

1. C Premium from selling option: +2.25 Option seller expire in the money (-1) Net gain: 1.25 2. B Bought Stock at 60, Premium received @ 3.60. So Investor has 3.60 extra to cover its downside (below 60), hence breakeven = 60 - 3.60 = 56.40 3. B The callable bond has negative convexity at low yields, so assuming if markets interest rates rises at low yield environment the decrease effect will not be as large as an option free bond. 4. A A putable bond gives the bondholder the option to sell the bond if its yields drop. Therefore the bondholder has also purchased a put option along with the bond. If volatility rises, so would the price of the option. Hence the price of the whole package will increase.

if interest rates rise the call option in the bond increases in value (to the issuer, so price down), just like with a regular stock option. so the bond will decrease more relative to option free bond, right?