FINA2322EFG Tutorial 2
THE UNIVERSITY OF HONG KONG
HKU BUSINESS SCHOOL
FINA2322EFG – DERIVATIVES
SECOND SEMESTER, 2023-2024
Tutorial 2 – Options payoffs
Positions Long call option Short call option
Right / Obligation have obligation to sell right to buy
have right to buy “buy right”
“buy right”
Example: If ST is… Payoff is… If ST is… Payoff is…
Assume the 30 -50 =-20 30 =0
exercise price is 40 -50 =-10 40 =0
$50 50 -50 =0 50 =0
60 -50 =10 60 =50-60=-10
70 -50 =20 70 =50-70=-20
Payoff Diagram
Profit Diagram
Cost
FINA2322EFG Tutorial 2
Positions Long put option Short put option
Right / Obligation have obligation to buy if
have right to buy “sell right”
option holder wants to sell
Example: If ST is… Payoff is… If ST is… Payoff is…
Assume the 30 50-30 =20 30 30-50 =-20=0
exercise price is 40 50-40 =10 40 40-50 =-10=0
$50 50 50-50 =0 50 50-50 =0
60 50-60 =-10=0 60 60-50 =10
70 50-70 =-20=0 70 70-50 =20
Payoff Diagram
Profit Diagram
Cost call primium不等於put premium receieve put premium
pay put premium
✓ Why would writer of an option willing to enter into a no-
win position?
▪ Premium
▪ Buyer and Seller of the options have different expectation towards price
fluctuation
▪ Often derivative contracts are traded before it is expired
✓ Quick Summary of option payoff graphs
Option payoff graphs:
w
⽂字
w
N
N*
2
FINA2322EFG Tutorial 2
✓ Equity Linked CD
Certificate of Deposits:
• Similar to deposits
• Usually with a longer investment horizon
• Offer higher interest rate
• If the issuing bank does not default, you get back principal + interest
Equity Linked CD:
• Usually with a longer investment horizon
• Mostly offer zero “guaranteed” interest rate
• Offer non-guaranteed interest rate equal to the positive return of the equity linked
• Equivalent to “Long Bond + Long Call”
Example:
Suppose you invest in a CD linked to HSI for 5 years by depositing $1000 today. The
current level of HSI is 25000.
How much do you get back if the HSI level in year 5 is
(i) 20000
(ii) 25000
(iii) 30000
Suppose the interest rate in Hong Kong is 1% p.a. for the coming 5 years. How much did
you pay as premium to buy the option in the equity linked notes?
Other example on Equity Linked Investment:
Suppose a ELI allows you to deposit $1000 with 20% interest rate p.a. for 1 year. The
investment is equity linked in a way that 1 year later, if the share price of Tencent is
lower than $600, you will need to use the entire principal together with interest (i.e.
$1200) to buy shares of Tencent at $600 per share. What is the composition of this
product?
3
FINA2322EFG Tutorial 2
Tutorial Exercise
For the following problems, assume the following:
Effective 6-month interest rate: 2%
S&R 6-month forward price: $1020
Premiums for S&R options with 6 months to expiration:
Strike (K) Call Put
$950 $120.405 $51.777
1000 93.809 74.201
1020 84.470 84.470
1050 71.802 101.214
1107 51.873 137.167
Question 1 (Profit and Payoff)
Verify that you could earn the same profit and payoff by:
I. Buying the S&R index for $1000 and
II. Buying a 950-strike S&R call, selling a 950-strike S&R put, and lending $931.37.
4
FINA2322EFG Tutorial 2
Question 2 (Option Payoff)
(a) Suppose you enter into a short 6-month forward position at a forward price of $50.
What is the payoff in 6 months for prices of $40, $45, $50, $55 and $60?
(b) Suppose you buy a 6-month put option with a strike price of $50. What is the payoff
in 6 months at the same prices for the underlying asset?
(c) Comparing the payoffs of part (a) and (b), which contract should be more expensive
(i.e. the long put or short forward)? Why?
