# Problem set 06 | Business & Finance homework help

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Fall, 2014

Problem Set 6

(Due Tuesday, Nov. 25)

1.   (5 points)

A fellow options investor tells you that he is going to enter an order to “buy to close.”  Explain exactly what he means.

2.   (2 points)

What is the difference between a European option and an American option?

3.   (54 points)

On Friday, Nov. 14, 2014, Alibaba stock (symbol BABA) closed at \$115.10 a share, up \$.26 on the day.  Consider the following chart giving the premium as of close of trading on that day on various options on Alibaba shares:

In the questions that follow, use the “Last Sale” column to answer questions which involve option pricing.

a.   (3 points)

What is the premium on the December, 115 call, i.e. the call option which expires on the third Friday of December of 2014, and has a strike price of \$115?

b.   (5 points)

How much would an investor who wanted to buy 1 contract of this option have had to spend (before considering any commission or fees)?

c.   (10 points)

What is the formula for the intrinsic value of a call?  What was the intrinsic value of the Dec. 118 call?  Was this option “in the money” or “out of the money”?  What was the time value of this option?

d.   (8 points)

Was the Dec. 114 call in or out of the money?  What was the intrinsic value of this option?  What was the time value of this option?

e.   (10 points)

What was the premium on the Dec. BABA 118 put?  Was this option in or out of the money?  What was the intrinsic value of this put?  What is the time value?

f.    (8 points)

What was the intrinsic value of the Dec. BABA 112 put?  Was this option in or out of the money?  What was the option’s time value?

g.   (10 points)

Based on the \$115.10 price of Alibaba’s shares as of the close on Friday, Nov. 14, what is the leverage on the Dec. 119 call?  Round your answer to two decimal places.

4.   (20 points)

Refer to the chart from question 2.  For each of the following, be sure to label all relevant points and amounts.

a.   (10 points)

Draw a hockey stick diagram for a short position in the BABA Dec. 119 call.

b.   (10 points)

Draw a hockey stick diagram for a long position in the BABA Dec. 118 put.

5.   (19 points)

National Consolidated Acme Co. (NCAC) stock could be one of five possible prices on January 16, 2015, the third Friday in January.  The prices and the probability that the stock ends up at each price are given in the following table:

 Probability 0.2 0.3 0.1 0.3 0.1 Stock Price 40 45 50 55 60

For each of the following questions, be sure to show all of your work.  Assume in each that markets are efficient.

a.   (5 points)

What is the current price of NCAC shares?

b.   (7 points)

What would be the premium of a January 45 NCAC call?

c.   (7 points)

What would be the premium of a January 50 NCAC put?

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