Part A A portfolio four separate European vanilla put options with varying strikes: P1(K1),P2(K2), P3(K3) and P4(K4). The portfolio is long in P1(K1)...

Part A

A portfolio four separate European vanilla put options with varying strikes: P1(K1),P2(K2), P3(K3) and P4(K4). The portfolio is long in P1(K1) and P4(K4) and short in P2(K2) and P3(K3). Assume that the four European vanilla put options are for the same underlying asset and have the same maturity (T) and have no interim cash flows (i.e. no dividends). Assume that each of the put options has a different strike (Ki) such that K1 < K2 <K3 <K4 and that the strikes are equally spaced apart.

1.Draw a payoff diagram at expiry of the trading strategy which illustrates what potential payoffs could be generated. Include Axis notation.

2.What is the lower boundary at expiry for the payoff value of the trading strategy described above for any series of four equally spaced strikes Ki.

3.What is the upper boundary at expiry for the payoff value of the trading strategy described above for any series of four equally spaced strikes Ki.

4.What type of volatility would suit this sort of payoff structure and why?

Part B

Compare and contrast the characteristics of " over the counter " and " exchange traded " markets, and the derivatives traded on those markets.