Exam #1



Name ____________________________ Last 4 (PSU ID) ________ First 2 letters of last name _____

Homework Assignment #1 – (142 points total) Econ 351 – Spring 2020 –PLEASE STAPLE, DUE, Friday February 7 AT THE BEGINNING OF CLASS: NO LATE HWS ACCEPTED.

YOU MUST USE THIS AS A TEMPLATE – THAT IS – MAKE MORE SPACE FOR YOUR ANSWERS IF YOU NEED TO BY HITTING ENTER (you certainly don’t need to type this assignment)– LEAVE THE QUESTIONS AS THEY ARE – AND PLEASE STAPLE! NOTEBOOK PAPER (OR ANY PAPER) STAPLED TO THE BACK IS NOT ACCEPTABLE (GETS A ZERO). ALSO, PLEASE PUT THE FIRST TWO LETTERS OF YOUR LAST NAME IN THE TOP RIGHT HAND CORNER OF THIS PAGE SO THAT WE CAN ALPHABETIZE THESE EASILY. THANKS IN ADVANCE!

1) (80 points total) Use the three tables below to answer the following questions

Table 1

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Table 2

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BE SURE TO SHOW ALL WORK, I KNOW SOME JUST PEOPLE JUST COPY ANSWERS – IF YOU JUST WRITE DOWN ANSWERS YOU GET ZERO CREDIT

As we know, Amazon reported earnings on Thursday, 1/30, after hours and beat expectations: From the NYT

Amazon Powers Ahead With Robust Profit

The internet giant posted increases in revenue and profit after shoppers flocked to it during the holiday season.

On Thursday, Amazon said it had earned $6.47 a share in the quarter, up from $6.04 a year earlier. Analysts had forecast $4.04 a share, and some would not have been surprised if it had been less. Amazon went wide last year with one-day shipping for members of its Prime service, and “fast” is usually synonymous with “expensive.”

As we also know, a current 351 student, Salem Adda-Berkane, “hit the jackpot” by buying a ‘bunch’ of call options before the earnings announcement.

In this problem, we are going to (kind of) replicate Salem’s trade and then add some more stuff. Note that I do not have the option tables before the announcement, just after. But that is okay, we can pretend we are making the bets before open on Friday, January 31.

Table 1 is for amzn options that expire on January 31 and Table 2 is for options that expire on February 7.

First, we need to calculate what the spot price of Amazon was before open: That’s easy!

2007.75 – 138.04 = 1869.71 = spot before open on Friday, 1/31.

Suppose we bought 10 call options with a strike price of 1870 before open. We need to calculate what the premium of the call options was before open.

For the Jan 31 calls: $13,900 – 10,330 = $3,570

For the Feb 7 calls: $14,225 – 9,805 = $4,420

For all option questions, use the 'Last' column for the premium of the option(s)... as we did/do in class.

a)(5 points) Why the difference in the premiums of the two 1870 call all options? To answer this question, calculate the term premium for both call options.

b)(5 points) Suppose you bought 10 Jan 31 1870 call options before the open on 1/31 and then closed your position at Table 1. What is your profit and rate of return? (round all returns to 2 decimal places and show all work)

c)(5 points) ) Suppose you bought 10 Feb 7 1870 call options before the open on 1/31 and closed your position at Table 2. What is your profit and rate of return?

d) (5 points) Suppose we play a long straddle by purchasing one Jan 31 1870 call and one Jan 31 1870 put before open on 1/31 and closed at Table 1. Calculate the profit/loss and rate of return. Note, you need to calculate the price of the put before open, like we did above with the calls.

For the Jan 31 puts: $1 + 3,329 = $3,330

e)(5 points) d) Suppose we play a long straddle by purchasing one Feb 7 1870 call and one Feb 7

1870 put before open and closed at Table 2. Calculate the profit/loss and rate of return. Note, you need to calculate the price of the put before open, like we did above with the calls.

For the Feb 7 puts: $290 + 3,837.5 = $4,127.5

f)(5 points) Explain why your rate of return is different in part d) vs. part e).

g (40 points for a correct and completely labeled graph with work shown) We are now going to graph the profit functions for the long and short straddle (Jan 31 straddles) as above where we opened up the positions before open. Suppose the price at expiration is as it is at Table 1. Identify the profit / loss for both players and label as points A (there are two point A’s). On the same graph, plot the profit functions for the long and short straddle (Feb 7 straddles) as above where we opened up the positions before open. Suppose the price at expiration is as it is at Table 2. Identify the profit / loss for both players and label as points B (there are two point B’s). Be sure to show all work. Also make sure you all breakeven (BE) points (there are four of them). Please show all work for your calculations.

h) (5 points) Look at the 1870 call in Table 1 which is after the closing bell on Jan 31, 2020 (the call has expired!). I argue that the premium has to be wrong - that is, that 1870 call cannot possibly be selling for $13,900. Why?? What is the correct price?

i)(10 points) We now consider what happened to the term premium of the Feb 7 call before and after the announcement – for this question only, we are using the Feb 07 1850 call. Recall that the spot price of amzn was $1,869.71 before open (and the earnings announcement). Calculate the term premium of this Feb 07 1850 call before the open and announcement. Now update everything and calculate the term premium of the Feb 07 1850 call in Table 2. Why such a big difference? Explain in detail. It only lost one day of life! Make sure you show all work.

2) (70 points total) Use the following 3 Tables to answer the following questions.

Table 1

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Table 2

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Table 3

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Suppose you played a short straddle by writing (selling) one 292.5 call and one 292.5 put (NFLX) at Table 1.

a)(5 points) Calculate the profit or loss if you closed at Table 2.

b)(5 points) Calculate the profit or loss if you closed at Table 3.

c)(5 points) Why is your profit/loss different in a) vs. b) above? Hint, there are two reasons!

d)(10 points) You were talking with a friend and they discussing the differences between playing a long straddle vs. playing a short straddle. Among other things, they were saying that time is your friend for one of the straddle bets and time is not your friend with the other straddle bet. Explain!

e)(10 points) Why do they call a long straddle a long straddle and why to the call a short straddle a short straddle? Explain in detail (this worth 10 points).

f)(25 points) In the space below, draw the profit function for the short straddle (only) that you played above. Consider three points: Point A, when the spot at expiration is as it at Table 1 = 293.75. Point B, where the spot at expiration is as it is at Table 2 = 288.51. Point C, where the spot at expiration is as it is at Table 3 = 290.17. Be sure to label the breakeven points.

g)(10 points) Suppose the spot at expiration is as it is at Table 2 = 288.51. Also suppose that the owner (purchaser) of the option that is in the money exercises that option. Go through the math and tell me exactly, what the exerciser of the option is doing and what you have to do, as the option writer, to honor the option that you wrote.

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