APPENDIX

Answers to the Chapter Exercises

Here are the answers to the exercises you read at the end of certain chapters. The exercise questions are repeated here for your convenience.

CHAPTER 2

1. GOOG closed today at $353.02 with only one day left in October’s options. Implied volatility of the Oct $350 call option is 241%. GOOG will announce earnings after the close.

a. Calculate the probability of the Oct $350 call expiring ITM (i.e., with the stock price > $350).

53%

b. Assume you are very bullish on GOOG; what is the probability of GOOG’s closing by expiration above $400?

16%

c. We would have to pay $7 or $700 for one contract of the Oct $400 calls. What will these calls be worth on expiration Friday (tomorrow) if GOOG closes at $408?

This option will open a little over $8 and decline through the day to $8 as time value decays.

d. Why is the implied volatility so high?

The upcoming earnings announcement after the close.

e. True or false: This extremely high IV means the market thinks GOOG is going much higher.

False. High IV implies a wide swing in price is expected, but that swing could be up or down.

f. What price range for GOOG would you predict for tomorrow with a 68% probability?

The current price of $353 ± 1σ = $44.5 or $309 to $398.

2. IBM is trading at $91.52, IV = 63%, and Nov options have 36 days to expiration. We buy a $70/$80 bull call spread for $8.80. Our maximum profit of $1.20 will occur if IBM closes on expiration Friday above $80. Our maximum ...