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21b - Chapter 21(Part 2 21(Part 2 Option Valuation Today...

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8/7/2011 1 Chapter 21 (Part 2) Option Valuation Today: Chapter 21 (Part 2) – Binomial Option Pricing, Synthetics, Portfolio Insurance Tuesday: Chapter 21 (Part 3) – Black-Scholes Binomial Model Review Pricing a 1-binomial period call option. Example 1 (1) Solve for hedge ratio, H. (2) Form risk-free hedge. (3) Appeal to the NAC. 100 S 1 1 130 20 S C (1) Solve for hedge ratio: (2) Form risk-free hedge: 0 0 110 1 C X ,T 1 1 80 0 S C call price spread 20 0 0 4 stock price spread 130 80 H . Long 0 4 shares of stock . (2) Form risk free hedge: (3) Appeal to the NAC: Short 1 call option 0 1 1 H f H V r V 0 0 4 100 1 10 32 . C . 0 32 40 10 91 1 10 C . .
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8/7/2011 2 2 Call Options with ( X = 110, T = 1) 0 0 100 6 06 S C . 1 1 120 10 S C 1 90 S 1 0 C 0 100 10 91 S C . 1 1 130 20 S C 80 S 0 1 1 0 C Asymmetrical Effect of Increased Variance C T X S T
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