Question

If you were a portfolio manager with a bullish view of the market and wanted to enter a spread position but had no current liquidity, would you be more likely to use calls or puts? Why?

The Black-Scholes-Merton formula requires a number of restrictive assumptions, including log-normality of the underlying asset’s value. By contrast, the pricing of futures and forwards requires relatively few assumptions. List the key assumptions necessary in calculating the price and value of futures contracts?

Answer 1

With the bullish view and no current liquidity, it would be more advisable to use the call options by designing bull spread that is by buying In-the-money call options and selling out-of-the-money call options. In this way, we could create a position without liquidity by capping the upside profits due to selling out of the money call options

Assumptions for forward market:

1. There is no transaction cost

2. Money can be borrowed and lended at the risk free rate

3. There no tax rates

4. Short seling is allowed

5. There are no arbitrage opportunity

6. Priced using Law of one price