University of Warwick Options Analysis and Valuation Question

University of Warwick Coventry

### Question Description

Need help with my Business question - I’m studying for my class.

1. A compound option is an option for which the underlying asset is another option (option on option). Therefore, there are two strike prices and two exercise dates. Let the strike price of the first and second strike prices X1 and X2 are \$2 and \$8, respectively, the time to maturity of first option T1 is 1 year and for the second option T2 equals 2 years. Consider both options as European Call options. Estimate the price of the compound option if the underlying asset of the second option is General Electric Co (GE) (with dividends). Use all relevant information for General Electric Co (GE) as in questions 1a.

using binomial trees with 20 time steps

800-1000 words

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Running head: OPTIONS ANALYSIS AND VALUATION

Options Analysis and Valuation
Institution Affiliation
Date

1

OPTIONS ANALYSIS AND VALUATION

2

The general outline of the algorithm used.
Set So=60,𝛿𝑡=1/10000,r=0.06,𝜎=0.033.Generate Si for i=1…..10000 by the following relation
Si=Si-1(1+r𝛿t+𝜎√𝑑𝑡∅)
THE STOCK’S VOLATILITY=3.33
Where ∅ is a standard normal random variate,a new one is taken at each step.
2. The above step is repeated N times so that we get N stock price realization vectors, each of the
length 252.We denote by Siji the ith day’s simulation in the jth realization.
3. For each price path, we calculate the average value given by the following formula;
Average=1/N∑10000I=0 Sji for j=1…N.
4. Calculate the payoff for each realization for both fixed and floating strike
FixedPayoffj=max (Averagej-E,0) (1)
FloatPayoffj=max (S251J-Averagej,0)

(2)

For j=1…N
5. Calculate the discounted average of each of the above values over j=1…. N
e-rEJ[Fixed Payoff]
e-rEJ[Float payoff]
6. Calculate the standard error of the vector of the N simulated values.
N
5
10
100
1000
10000

ArthFixed
2.37
3.90
3.03
3.49
3.45

ArthFloat
2.44
2.59
3.31
3.36
3.52

GeomFixed
4.55
1.75
3.34
3.29
3.28

GeomFloat
1.98
5.35
3.52
3.52
3.50

Vanilla
7.61
6.60
7.17
5....

ProfJamesmiller (20534)
University of Maryland
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Anonymous
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Anonymous
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Anonymous
Excellent job

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