Essay About Put Option And Price Of K.Binomial Model

Derivatives Question and Answers
Essay Preview: Derivatives Question and Answers
Report this essay
Payoff Diagrams (16p)Draw the gross payoff (not net-payoff/profit) diagram as a function of MLM stock for the following portfolios consisting of: (Strike values are given in parentheses)one long position in the stock and two short positions in the same put option (K).two long positions in the stock, two short call options (2K), and one long position ina put (K).two short positions in the stock, two long call options (2K), and one short put option(3K).one long position in the stock, two short call options (2K), two short call options (3K),and one short put option (2K). For this question, take into account the net profit only for the stock. You can assume that the stock is purchased at a price of K.Binomial Model (27p)Chevron Corporation has stakes in various oil development projects in Yemen and is considering to bid on a development of a new oil platform in Yemen in the future. However, due to ongoing civil war in Yemen and the instability of the Yemeni Currency (YER), Chevron wants to be hedged against two possible scenarios:First scenario: The country becomes stable in the future and Chevron decides to go on with the bid and the bid is accepted, in that case Chevron would need Yemeni Rial (YER).Second scenario: The country’s situation deteriorates and Chevron is forced to liquidate its current assets, in that case Chevron would want to exchange Yemeni Rial for USD and would want to be hedged against a possible depreciation of the currency.Chevron approaches J.P Morgan and asks for a derivative on the Yemeni Rial currency exchange rate that would hedge the company’s interests in both scenarios. J.P. Morgan suggests an exotic option on YER/USD. More specifically, the bank suggests a three-year chooser option. The chooser option is a special type of option contract that allows the purchaser to decide during a predetermined period of time whether the derivative will be a European put or a European call option. This way, Chevron can choose later, after two years, if the option is a call or put after, when it has more certainty about the future scenario. Assume that the constant risk-free rate is 4% (using continuous compounding) and that the estimated monthly sample standard deviation of the underlying YER/USD currency exchange rate is 6.35%. Using a three-step binomial tree with a time step of 1 year, calculate the following:Calculate u, d (the up and down multipliers in the binomial tree), and the risk neutralprobability of an upward move, p.Assume that the current YER/USD exchange rate is 224 (S0 = 224 ), and draw the binomial tree of the underlying asset of the option.Use the binomial tree to find the value of a simple three-year European put option onthe YER/USD exchange rate at t=0, with the strike price of K=235. How would your answer change if the option was American?Assume that the strike prices of the chooser call and put options are 230 and 235,respectively. Calculate the value of the chooser option at time zero, considering that Chevron has to make the decision on whether the option is call or a put at t=2.Given the high volatility of the underlying YER/USD currency exchange rate, Chevronbelieves that the option is expensive. In addition, there is some uncertainty for scenario 1, i.e., if Chevron’s bid on the new oil project would not be accepted, then the money spent on the option would be wasted. In order to address this concern, J.P.Morgan suggests a compound option instead.[1] More precisely, J.P. Morgan suggests that Chevron buys a second chooser option on the value of the original chooser option, for which the price was calculated in part (d). For the second chooser option, the decison that the option is a call or a put is made at t=1, and the strike prices for the call and the put options are 100 and 54 respectively. Using a binomial tree, calculate the value of the compound option at t=0.What would be the benefits or downsides of using the compound option given thedifferent possible scenarios? Explain briefly!Black-Scholes-Merton Model (32p)Go to the website of the Montreal Exchange (