Suppose today is December 2020 and you are analyzing Arbitrage Before-Cash (ABC) Inc. which is a non-dividend paying firm that is currently trading at $20 a share. Given your analysis, you believe that the stock will either increase by 20% or drop by 15% in 6-months. Given your forecasts and appetite for arbitrage opportunities, you've set your sights on ABC's June 2021 $18, $20, and $22 Call and Put Options to try and identify any mispriced options. Below is a screenshot of a quote on the above-mentioned options: EXPIRY CALLS EXERCISE PUTS Jun-21 $3.00 $18.00 $0.60 Jun-21 $2.20 $20.00 $1.30 Jun-21 $1.00 $22.00 $2.20 Assume that the annual risk-free rate is 8.16% and all options have exactly 6-months to expiry. A. Use the binomial option pricing model to verify if the $18 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (4 Marks) B. Use the risk-neutral valuation to verify if the $20 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (3 Marks) C. Use the put-call parity to verify if the $22 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (4 Marks) D. Suppose you wrote 15 of the $20 Call Options (each contract is 100 shares) for $2.20 and held them until expiry at which point ABC is selling for $24 a share. Calculate your P&L at expiry. (4 Marks) Suppose today is December 2020 and you are analyzing Arbitrage Before-Cash (ABC) Inc. which is a non-dividend paying firm that is currently trading at $20 a share. Given your analysis, you believe that the stock will either increase by 20% or drop by 15% in 6-months. Given your forecasts and appetite for arbitrage opportunities, you've set your sights on ABC's June 2021 $18, $20, and $22 Call and Put Options to try and identify any mispriced options. Below is a screenshot of a quote on the above-mentioned options: EXPIRY CALLS EXERCISE PUTS Jun-21 $3.00 $18.00 $0.60 Jun-21 $2.20 $20.00 $1.30 Jun-21 $1.00 $22.00 $2.20 Assume that the annual risk-free rate is 8.16% and all options have exactly 6-months to expiry. A. Use the binomial option pricing model to verify if the $18 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (4 Marks) B. Use the risk-neutral valuation to verify if the $20 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (3 Marks) C. Use the put-call parity to verify if the $22 Calls and Puts in the above quote are appropriately priced. If not, what should the appropriate prices be? (4 Marks) D. Suppose you wrote 15 of the $20 Call Options (each contract is 100 shares) for $2.20 and held them until expiry at which point ABC is selling for $24 a share. Calculate your P&L at expiry. (4 Marks)
