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Question One:

(a)

Explain why an increase in volatility increases the range of both good and bad outcomes for a stock, yet it unambiguously increases the value of an option.

(b)

Consider each of the following arrangements, and determine whether it is an option. If so, decide whether it is a call or a put and identify the premium.

a) you purchase homeowner’s insurance for your home

b) you enter into a non cancelable, long-term apartment lease

c) you are a high school senior evaluating possible college choices. One school promises that if you enroll it will guarantee your tuition rate for the next four years.

Question Two;

Exxon’s common stock is selling at $150. You can buy a 6-month call option to exercise at $150 for $12, and a put option for the same maturity and exercise price for $9. Plot the option profit function for each option separately, and for an investment in one call and one put held simultaneously. What are the breakeven stock prices at expiration?

Question Three:

(a)

Discuss and compare the two bullish strategies of buying a call and writing a put. Why would one strategy be preferable to the other? Make sure you include diagrams in your discussion.

(b)

Suppose you wish to buy stock and to protect yourself against a downside movement in its price. You consider both a covered call and a protective put. What factors will affect your decision? Make sure you include a description and a diagram outlining both strategies.