Question

Answer the following with True/False:

1. You buy a put and a call option simultaneously in a protective put.   
2. For put-call parity to hold, the exercise price of call and put options must be similar.
3. The formula for continuous discounting is FV (e ^-rt) .
4. The minimum value for a put option can sell, can be written as Max (0, P - E).
5. The intrinsic value of an in-the-money call option is written as: C=P₀ - E.  
6. d₁ and d₂ are quantities for standard deviation (σ).

Answer 1

You buy a put and a call option simultaneously in a protective put.   

Solution:

False, in a protective put, you go long on a stock and purchase a put option to cover those stocks. The strategy under which we long call as well as put option is called long straddle.

For put-call parity to hold, the exercise price of call and put options must be similar.

True, for put call parity to hold, the exercise price, the expiration date and the underlying asset must be similar. The options that we are talking about are usually European in nature. The parity does not apply to American options as they can be exercised at any point in time before its expiration date.

The formula for continuous discounting is FV (e ^-rt) .

True, the formula for continuous discounting is same. In this formula, FV represents the future value, r represents the rate of return, t represents the time period.

The minimum value for a put option can sell, can be written as Max (0, P - E).

False. Let's say P is the spot price and E is the exercise price. In this case, the actual minimum value for a put option would be Max(0, E - P). Only if the exercise price is greater than the spot price, put option's value will be positive else the option would be worthless because its holder can sell the underlying asset in the market for a better price.

The intrinsic value of an in-the-money call option is written as: C=P₀ - E.  

True. Considering P₀ to be the current stock price and E to be the strike price, the intrinsic value of in the money call option is equal to the difference between the current stock price and the exercise price.

d₁ and d₂ are quantities for standard deviation (σ).

False. In Black Scholes Model, d₁ and d₂ are conditional probability and the probability that the call option will expire in the money respectively, rather than the quantities of standard deviation. However, calculation of d₁ and d₂ does involve values of standard deviation.