Question
A non-dividend paying stock currently trades for $25 and has an annualised return standard deviation of 15%. Given that the continuously compounded risk-free rate of
A non-dividend paying stock currently trades for $25 and has an annualised return standard deviation of 15%. Given that the continuously compounded risk-free rate of return is 4% p.a., complete the following:
a. Using a two-step binomial tree, price the American put option on the stock when the put has an exercise price of $26 and 6 months to maturity.
b. I have just sold 500 European call options written over shares in ABC Bank. The stock is currently trading for $40 a share and has a return standard deviation of 20% p.a. The options mature in 2 months and have a strike price of $40. The continuously compounded risk-free rate of return is 5% p.a. Explain exactly how I can trade today in the underlying shares to hedge my market risk. How often should I rebalance my portfolio?
c. Discuss how an increase in an options strike price would affect its delta if it was a call or a put, holding all other variables constant.
d. Explain the concept of implied volatility and how it can be a useful measure of market expectations.
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