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Risk Management: Principles and Applications - Assignment Example

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Risk Management: Principles and Applications

If the market price for the asset is greater than the strike price, it will be worth while for the holder to use the option. In this instance the option writer is forced to trade the asset to the option owner. The price at which a call is traded is called premium. In the case of calls, a higher stock price means that other things being equal; the option is more likely to be in the money on maturity. Therefore, a higher S is associated with a higher premium (Hull, 1997). Conversely, the higher the exercise price K, the lower is the premium. A higher exercise price makes it less likely that the option will be in the money on maturity. The time to maturity t has appositive effect on the option price: the greater t is, the more time the stock price has to climb above the exercise price. The volatility of the stock measured by the standard deviation of its returns ?, a;so has a positive influence on the call price. This due to the fact that call option holders are only concerned with the gain potential of their option, and this is greater the higher is the likelihood that the option will be beneficial on ripeness. Finally, the rate of interest, r has a positive influence on the call price. The greater the rate of interest r, the lower the strike value to be paid on maturity (e-rtK). The price of a call is given as C=S. N (d1) –K. e-rt. ...
263 v0.25= 0.9532 d2= 0.9532-v0.263 v0.25=-0.06968 Nd1=0.3289 Nd2= 0.0239 Replacing them in C= (879000) (0.3289) - 227,349.9673 (0.0239)= $ 23,476.6458 Using put option Put options are the options which give the holder the right to sell the specified asset at the specified price. They are issued by sellers or their writers. The price of an option is known as premium. The value at which the underlying asset can be sold is called the strike price (Brigham, Gapenski & Ehrhardt, 1999). If you have a long position, one of the strategies to be utilized in order to hedge against a price decline is a long position in puts. One could buy put options to be fully hedged against price decline, but could still profit from price raise. The purchaser of put options can hedge their drawback price risk for a time and still gain from the potential price increases if the market should rise. The holder pays a certain premium to shield against a likely loss. Once the premium is remunerated, the holder has no further obligation. Depending on value progress, the manufacturer can either take or leave the assured price. If the price of the stock goes down, one has a price protection with the put option at the selected strike price. The same aspects that influence the cost of a call, also influence the price of put options on stocks. The premium on puts is now a decreasing function of the stock price and an increasing function of the exercise price. The conditions that should be fulfilled for a put to be in money: an increasing function of the time to maturity and the volatility of the stock, and a decreasing function of the rate of interest: this last result is owing to the truth that an elevated rate of interest decreases the present worth of the exercise cost to be received on prime of life. ...Show more


Risk Management: Principles and Applications Options on stocks Options on stocks give their owner the right to purchase or trade shares of a particular stock, at a specified price. It is vital to compare the market price of the stock, with the exercise price of the option (Hull, 1997)…
Author : mcummings
Risk Management: Principles and Applications
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