A trader observes an American option and a European option with the same strike price, expiration, and underlying stock. He believes that the European option will have a higher premium than the American option. Critique his belief that the European option will have a higher premium.
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4a) A trader observes an American option and a European option with the same strike price, expiration, and underlying stock. He believes that the European option will have a higher premium than the American option. Critique his belief that the European option will have a higher premium.
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- Under the assumptions of the Black-Scholes model, which value does not affect the price of a European call option: Select one: a. the interest rate r b. the spot price S c. the strike price K d. the return of the stock µ e. the volatility of the stock σWhich of the following statements about European option contracts is TRUE? a. Typically American options are cheaper than otherwise similar European options due to the uncertainty regarding the date of exercise. b. One can synthesise a long forward position in the underlying by being long a call and short a put c. A long call position and a short put position both involve buying the underlying and so are equivalent d. The price of an option can be obtained by computing the true probabilities of each state of nature, working out the expected option payoff across those states and then discounting back to the present.a)describe the major differences between forward contracts and option contracts. b)discuss an arbitrage opportunity when an option is mispriced. c) identify, analyze, and discuss the following characteristics of an American call option: maximum value, intrinsic value, time value, lower bound, and payoff at expiration. d) analyze and discuss the following factors on an American call option: time to expiration, exercise price, interest rate, volatility, and dividends.
- Which of the following statements about European option contracts is true? Question 2Answer a. Typically American options are cheaper than otherwise similar European options due to the uncertainty regarding the date of exercise. b. The price of an option can be obtained by computing the true probabilities of each state of nature, working out the expected option payoff across those states and then discounting back to the present. c. A long call position and a short put position both involve buying the underlying and so are equivalent d. One can synthesise a long forward position in the underlying by being long a call and short a putMy question is for a synthetic call option why do we need to borrow the present value of the strike price and what does it mean in a simple language explanation. Similarly why do we need to lend the present value of the stock at risk-free rate and what does it mean in simple language explanation? Please also clarify the significance of risk free rate? Why is it used in put call parity. Synthetic Call Option: If an investor believes that a call option is over-priced, then he/she can sell the call on the market and replicate a synthetic call. Borrow the present value of the strike price at the risk free rate and purchase the underlying stock and a put. Synthetic Put Option: Similar to the synthetic call option. A synthetic put can be created by re-arranging the put-call parity relationship, if the trader believes the put is overvalued. Synthetic Stock: A synthetic stock can also be created by rearranging the put-call parity identity. In this case, the investor will buy the…Suppose that C is the price of a European call option to purchase a security whose present price is S. Show that if C>S then there is an opportunity for arbitrage (i.e. risk-less profit). You may assume the interest rate is r=0 so that the present value calculations are unnecessary.
- Discuss which of the following statements is true. O I. An American call option is more expensive than a European call option because of the time value of money. O II. An American call option is more expensive than an American put option because call options give the right to buy the stock and not to sell it. O II. An American put option is more expensive than a European put option because of the time value of money. O IV. An American call option is cheaper than a European call option because we lose the insurance value of the call if we exercise early.(d) The upper and lower bounds on option prices must be satisfied irrespective of the underlying price of the option. Therefore, explain the upper and lower bounds that must be satisfied by options prices and carefully outline how an investor or trader could profit in this context.Which of the following statements is true about call options? A.The holder of the option profits when the price of the underlying asset increases. B.It gives to the buyer of the option the right to sell a financial instrument within a specific time period, at a specified price. C.The holder of the option will exercise the option only if the price of the underlying asset is smaller than the strike price. D.The holder of the option receives a premium for writing the option.
- i)identify, analyze and discuss the following characteristics of an American put option: maximum value, intrinsic value, time value, lower bound, and payoff at expiration. ii) analyze and discuss the following factors on an American put option: time to expiration, exercise price, interest rate, volatility, and dividends. iii) identify, analyze, and discuss the following characteristics of a European call option: maximum value, intrinsic value, time value, lower bound, and payoff at expiration. iv) analyze and discuss the following factors on a European call option: time to expiration, exercise price, interest rate,2) Which of the following statements is FALSE? A) The option buyer, also called the option holder, holds the right to exercise the option and has a long position in the contract. B) The market price of the option is also called the exercise price. C) If the payoff from exercising an option immediately is positive, the option is said to be in-the- money. D) As with other financial assets, options can be bought and sold. Standard stock options are traded on organized exchanges, while more specialized options are sold through dealers.Discuss which of the following statements is true. I. An American call option is cheaper than a European call option because we lose the insurance value of the call if we exercise early. II. An American call option is more expensive than a European call option because of the time value of money. III. An American call option is more expensive than an American put option because call options give the right to buy the stock and not to sell it. IV. An American put option is more expensive than a European put option because of the time value of money.