Question

In: Finance

A strategy consists of buying a market index product at $830 and longing a put on...

A strategy consists of buying a market index product at $830 and longing a put on the index with a strike of $830. If the put premium is $18.00 and interest rates are 0.5% per month, what is the estimated price of a call option with an exercise price of $830? Please show step by step

Solutions

Expert Solution

Let us assume that the duration of the option is one month.

As per the PUT-CALL parity formula:

P = C - S + PV(X)

Where, P = Premium of PUT option
C = Premium of CALL option
S = Spot price or the current Index price
PV(X) = Present value of the strike price

Here, the premium of Put option is given, we are supposed to calculate premium of Call option

Therefore, C = P + S - PV(X)

PV(X) can be calculated on Microsoft Excel

Following are the steps to be followed on Microsoft Excel:

Step 1: Click on "FORMULAS" tab at the top of Microsoft Excel
Step 2: Select the option "Financial"
Step 3: Under "Financial" select the option "PV"
Step 4: Insert Rate = 0.05 Nper = 1 / 12 FV = -830

PV = 826.63

Therefore, C = P + S - PV(X)

= 18 + 830 - 826.63

= 21.37

Hence, the Call option premium is $21.37


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