IAI Actuarial Core Principles · Economic Modelling · Principles of option pricing
An investor buys a share at Rs 200 and buys a European put on it with strike Rs 190 for a premium of Rs 8. Ignoring interest, what is the investor's minimum total profit at expiry of the combined position?
The worst outcome is a loss of Rs 18. The put guarantees a combined value of at least Rs 190, which is Rs 10 below the purchase price, and the Rs 8 premium adds to the loss, giving 190 - 200 - 8 = -18.
- A-Rs 8
- B-Rs 10
- C-Rs 18Correct
- D-Rs 2
- -Rs 28
Explanation
If the price falls below 190, the put pays 190 - S, so share plus put is worth 190. Profit = 190 - 200 - 8 = -18. Option A ignores the Rs 10 fall to the strike. Option B ignores the premium.
Did you get it right without looking?
One question tells you little. A timed set on Principles of option pricing shows your real accuracy, how long you take and where you lose marks.
More Principles of option pricing questions
- In a binomial option pricing model, which statement about the risk-neutral probability q is correct?
- A non-dividend-paying share trades at Rs 100. A one-year European call with strike Rs 100 is worth Rs 10.45 under Black-Scholes with a conti…
- A European put on a non-dividend-paying share has strike Rs 200, expiry in one year and the risk-free force of interest is 5% per year (e^-0…
- A share priced at Rs 400 will pay a certain dividend of Rs 10 in 3 months. European call and put options expire in 6 months with strike Rs 4…
- A share is expected to pay a large dividend before the expiry of two options on it, a European call and a European put. Compared with an oth…
- Which of the following is the main reason why an American put option on a non-dividend-paying share may be exercised early?