Q2

(a)Suppose XYZ is a non-dividend-paying stock. Suppose S = $100, = 40%, = 0,

and r = 0.06.

(i)What is the price of a 105-strike European call option with 1 year to

expiration?

(ii)What is the price of a 105-strike European put option with 1 year to

expiration?

(iii)Verify the put-call parity.

(b)

Market maker is taking position in 1 million units of the following bull

spread: buy a 40- strike call and sell a 45-strike call. Suppose S = $40, =

0.30, r = 0.08, = 0, and T = 0.5.

(i)How does market maker hedge the bull spread position? How many shares to buy or

short sell? How much money to borrow or lend?

(ii)Suppose one day later, the stock price is $41. What is the overnight profit of

market maker's delta-hedged position?