1. What is a derivative, how does it differ from a stock or bond? (4%)
2. How do price limits work with futures? Do all futures contracts have limits? (4%)
3. What is the definition of a call option? (4%)
4. What is the difference between an American and European option? (4%)
5. Are exchange-listed options adjusted for the payment of an ordinary dividend?
If so, what about the option is adjusted? (4%)
6. Do buyers of call options have to post margin? Why is this? (4%)
7. What is meant by the term ‘naked’ in relation to options? (4%)
8. Is the delta of a long call option positive or negative? (4%)
9. Define Vega, how does an increase in volatility affect the price of call options? (4%)
10. Using just a call option (which controls 100 shares) with a delta of 0.5 and the underlying
stock, how might you put on a delta neutral position that is long volatility? (4%)
LONG QUESTIONS (20%)
11. (Part 1) Using the formula for Put Call Parity, what combination can you make of options
positions and the underlying to replicate a short put position?
(Part 2) Define a Bear Spread. What kind of market move are you hoping for if you are
long a bear spread? Can it be constructed using puts or calls, or both?
12. Use a 2 step binomial tree to value a put option. (20%)
All of the steps in your calculation should be shown including the calculation of P and
the calculation of each of the option nodes U, D, UU, UD & DD.
Assume that at each node the stock moves up 20% or down 20%
The option expires in 2 years. The interest rate is 5% continuously compounded.
The spot price is 100 and the option strike price is 104
Early Exercise is not possible with this option.
13. Explain in your own words what dynamic hedging is, and how a trader could profit by
dynamically hedging an option if they have a forecast of volatility that is different to implied
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