Question

In each of the following questions, you are asked to compare two options with parameters as given. The risk-free interest rate for all cases should be assumed to be 6%. Assume the stocks on which these options are written pay no dividends.

a. Which put option is written on the stock with the lower price?

(1) A

(2) B

(3) Not enough information

b. Which put option must be written on the stock with the lower price?

(1) A

(2) B

(3) Not enough information

c. Which call option must have the lower time to expiration?

(1) A

(2) B

(3) Not enough information

d. Which call option is written on the stock with higher volatility?

(1) A

(2) B

(3) Not enough information

e. Which call option is written on the stock with higher volatility?

(1) A

(2) B

(3) Not enough information

Short answer

a. (1)

b. (2)

c. (2)

d. (2)

e. (3)

Step-by-step solution

Explanation on ‘a’

If put A is not written on the lower priced stock, it would sell; for less than Put A because of lower volatility of stock A. Therefore the correct option is option (1).

Explanation on ‘b’

Write put on the stock B with lower price for higher value. Therefore the correct option is option (2).

Explanation on ‘c’

Since call B has a lower time to maturity, therefore it is cheaper than call A. Therefore the correct option is option (2).

Explanation on ‘d’

Since call B has a higher price, the correct option is option (2).

Explanation on ‘e’

Since the values given are consistent with either stock having high volatility, the question doesn’t have appropriate information. Therefore the correct option is option (3).