Explain to your Aunt Betty the relationship between call value and time-to-expiration of the option. Is this relationship confirmed by your calculations in #10? 2) Explain to your aunt the relationship between call value and the risk-free rate. Illustrate your explanations by calculating the call value of the 42-call with one-month expiry at effective risk-free rates of 0.5%, 1.5%, and 2.0%.
Your Aunt Betty has a $120,000 investment portfolio comprising some Government of Canada three-month Treasury Bills and 2,000 Suncor shares. When the portfolio was formed (one month ago), the shares were worth $85,700 and the bonds were worth $34,300. Today, Suncor shares are worth $41.94 per share, while the bond yields have decreased so that the bonds are now worth $38,000. The effective yield on the three-month Canada Treasury Bill is 0.94% per annum.
Aunt Betty is a bit concerned about the drop in value of her Suncor shares and consequently, her overall portfolio value. Knowing that you are taking a finance course, she consults you to see what she can do to protect her portfolio from a further drop in value. She has heard a lot about call and put options and would like to know more about these.
You immediately go online to look for information on options on Suncor shares. You find the following pricing information on the call options (Table 1) and the put options (Table 2) on Suncor, with expiry in one month:
Table 1: Call option prices
|
Strike |
Last |
Chg |
Bid |
Ask |
Vol |
Open Int |
|
41.50 |
0.43 |
–0.01 |
0.42 |
0.45 |
98 |
96 |
|
42.00 |
0.33 |
+0.13 |
0.36 |
0.39 |
101 |
38 |
|
42.50 |
0.12 |
+0.02 |
0.10 |
0.16 |
62 |
11 |
|
43.00 |
0.05 |
0.00 |
0.05 |
0.08 |
2 |
12 |
Table 2: Put option prices
|
Strike |
Last |
Chg |
Bid |
Ask |
Vol |
Open Int |
|
40.50 |
0.10 |
0.00 |
0.09 |
0.10 |
5 |
5 |
|
41.00 |
0.06 |
–0.18 |
0.04 |
0.06 |
10 |
12 |
|
41.50 |
0.13 |
–0.18 |
0.10 |
0.13 |
48 |
57 |
|
42.00 |
0.39 |
–0.48 |
0.30 |
0.39 |
91 |
1 |
|
42.50 |
1.22 |
0.00 |
1.00 |
1.25 |
64 |
64 |
- Explain to your Aunt Betty the relationship between call value and time-to-expiration of the option. Is this relationship confirmed by your calculations in #10?
2) Explain to your aunt the relationship between call value and the risk-free rate. Illustrate your explanations by calculating the call value of the 42-call with one-month expiry at effective risk-free rates of 0.5%, 1.5%, and 2.0%. Assume that your aunt’s projections of down- and up-movements of Suncor remain the same for these risk-free rates.
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