Tutorial 1

Tutorial 1

Textbook: Fundamentals of Futures and Options Markets by John C. Hull. Pearson new International Edition. Ed 8. ISBN number: 978-1-29204-190-2

Note: Questions with * must be covered in tutorial class

Problem 1.10.

Explain why a futures contract can be used for either speculation or hedging.

If an investor has an exposure to the price of an asset, he or she can hedge with futures contracts. If the investor will gain when the price decreases and lose when the price increases, a long futures position will hedge the risk. If the investor will lose when the price decreases and gain when the price increases, a short futures position will hedge the risk. Thus either a long or a short futures position can be entered into for hedging purposes. If the investor has no exposure to the price of the underlying asset, entering into a futures contract is speculation. If the investor takes a long position, he or she gains when the asset’s price increases and loses when it decreases. If the investor takes a short position, he or she loses when the asset’s price increases and gains when it decreases.

Problem 1.13.

Suppose that a March call option on a stock with a strike price of $50 costs $2.50 and is held until March. Under what circumstances will the holder of the option make a gain? Under what circumstances will the option be exercised? Draw a diagram showing how the profit on a long position in the option depends on the stock price at the maturity of the option.

The holder of the option will gain if the price of the stock is above $52.50 in March. (This ignores the time value of money.) The option will be exercised if the price of the stock is above $50.00 in March. The profit as a function of the stock price is shown in Figure S1.1.

Figure S1.1 Profit from long position in Problem 1.13

Problem 1.25*

A trader sells a put option with a strike price of $40 for $5. What is the trader’s maximum gain and maximum loss? How does your answer...