Two Economics of Derivatives questions
1. Assume that you think that volatility will increase. What European options portfolio offers you a potential gain from higher volatility if you do not care whether the price will go up or down. Please explain your answer.
2. You are interested in creating the following payoff profile using options. What European options would you hold in your portfolio and at what strikes? Assume that the desired payoffs at expiration are zero for any stock price less than 100 or more than 160.
Stock Price 100 110 120 130 140 150
Payoff at expiration 0 10 30 10 0 -10
a. Explain whether the trader can engage in arbitrage?
b. If so, what positions would the trader take and what profit might it make at expiration?