SCHOOL OF MATHEMATICAL SCIENCES
MAT 2094 DERIVATIVE SECURITIES II
(TUTORIAL 3 – MARKET-MAKING AND DELTA-HEDGING)
Question 1
A market-maker sells at-the-money straddle on a stock. You are given:
(i) The stock’s price follows the Black-Scholes framework.
(ii) S (0) = 45.
(iii) The continuously compounded risk-free rate is 0.10.
(iv) The stock pays no dividends.
(v) The annual volatility of the stock is 0.2.
(vi) The straddle consists of European options and expires in one year.
The market-maker delta-hedges the sale by buying shares of the underlying stock. Calculate the
amount of money the market-maker spends on the stock.
Question 2
For a 91-day European call option on a stock in the Black-Scholes framework, you are given:
(i) The price of the stock is 50.
(ii) The strike price is 55.
(iii) The continuously compounded risk-free interest rate is 0.05.
(iv) The stock pays no dividends.
(v) = 0.2.
You write the option and delta-hedge it. Calculate the 1-day mark-to-market profit on a delta-
hedged portfolio for this option if the stock price increases to 55.
Question 3
You are given the following information for a delta-hedged portfolio for a European call option
that you have written:
Stock price Call premium Call delta
Day 0 55 6.5 0.4
Day 1 60 9.5 0.6
The continuously compounded risk-free interest rate is 0.05. Calculate the number of shares to buy
or sell on day 1 to maintain the delta hedge.
MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies
SCHOOL OF MATHEMATICAL SCIENCES
Question 4
A market-maker sells a bear spread consisting of a 40-strike put and a 45-strike put on a stock.
You are given:
(i) The continuously compounded risk-free rate is 4%.
(ii) The stock pays no dividends.
(iii) The options are European, and are priced using the Black-Scholes formula.
(iv) The market-maker delta-hedges the bear spread.
Strike price 40 45
Day Stock price Put premium Put delta Put premium Put delta
0 35 6.45 -0.644 10.43 -0.800
1 40 3.74 -0.435 6.85 -0.622
(a) Determine the investment required by the market-maker on day 0, including the option
premiums, to sell the bear spread and delta-hedge it.
(b) Determine the investment required on day 1 to maintain the delta hedge.
Question 5
An investor bought a European call option on a stock and delta-hedged with the stock. Later on,
but before expiry of the option, he closed the position. Given:
(i) The stock was worth 40 when the call option was bought and 50 when it was sold.
(ii) The call was worth 4.25 when it was bought and 9.30 when it was sold.
(iii) A European put option with the same strike price and expiry was worth 8.50 when the call
option was bought and 5.80 when it was sold.
(iv) was 0.3 when the call option was bought.
(v) The stock pays no dividends.
Determine the amount of profit, including interest, that the investor made.
Question 6
For A European put option on a stock with price 50, the put premium is 1.84, is -0.42 and is
0.014. Determine the approximate value of the put if the stock’s price increases to 52
instantaneously.
MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies
SCHOOL OF MATHEMATICAL SCIENCES
Question 7
For a European call option on a nondividend paying stock with one year to expiry:
(i) The stock follows the Black-Scholes framework.
(ii) The price of the stock is 40.
(iii) The strike price is 50.
(iv) Gamma for the option is 0.0425.
(v) The continuously compounded risk-free interest rate is 0.07.
The price of the stock jumps to 40.50 and the price of the option increases by 0.0915. Determine
the implied volatility of the stock based on the delta-gamma approximation.
Question 8
For a European call option on a stock you are given:
(i) The option premium is 2.50.
(ii) = 0.3.
(iii) = 0.05.
(iv) = −0.7 per year.
Determine the approximate value of the call option 7 days later if the stock price increases by 0.25.
Question 9
You write a 3-month European put option on a stock with strike price 40, and delta-hedge it by
buying x 1-year European put options on the same stock with strike price 40. Given:
(i) The price of the stock follows the Black-Scholes framework.
(ii) The price of the stock is 40.
(iii) The volatility of the stock is 0.2.
(iv) The stock pays continuous dividends at a rate of 0.02.
(v) The continuously compounded risk-free rate is 0.08.
Determine x.
MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies
SCHOOL OF MATHEMATICAL SCIENCES
Question 10
You are given the following information for two European call options on a stock priced using the
Black-Scholes formula:
45-strike call 50-strike call
Price 14.9835 10.2270
0.9320 0.9300
0.0030 0.0160
Determine the number of shares of stock and the number of 50-strike calls one must buy or sell to
delta-gamma hedge a sale of 45-strike call, given a stock price of 60.
Question 11
You are given the following information for three European call options on a stock, priced using
the Black-Scholes formula:
40-strike call 45-strike call 50-strike call
0.5688 0.2734 0.1181
0.0598 0.0524 0.0301
-0.0145 -0.0118 -0.0512
A market-maker selling a 40-strike call delta-gamma-theta-hedges it with the underlying stock and
45- and 50- strike call options. Determine the number of shares of stock and 45- and 50- strike
calls that must be bought or sold to effect this hedge.
Question 12
For a European call option on a nondividend paying stock, you are given:
(i) The stock price is 47.
(ii) = 0.2.
(iii) = 0.8704.
(iv) = 0.0380.
(v) = −0.00842 per day.
(vi) The price of the option is 5.9642.
Determine the continuously compounded risk-free interest rate.
MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies
SCHOOL OF MATHEMATICAL SCIENCES
Answers:
1. 20.318
2. -0.8377
3. Buy 0.2 shares
4. (a) -9.44, (b) -1.2410
5. 2.44
6. 1.028
7. 0.15
8. 2.5631
9. 1.2395
10. Buy 0.757625 shares of stock and buy 0.1875 50-strike calls
11. Buy 0.2577 shares of stock, 1.1279 45-strike calls, and 0.0233 50-strike calls
12. 0.04
MAT 2094 Derivative Securities II BSc (Hons) in Actuarial Studies
