Ckdropsdtimes valueofstockspayofffromcallasawriter

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Unformatted text preview: is $40. • Exercise price of Call option = $35 Option Pricing Option Pricing ­ Binomial Option Pricing Model Initial Investment in the Portfolio = Cost of buying stocks – Receipt from selling call = HS ­ C Payoff at end of 1 year (if price of stock rises u times) = Value of stocks – payoff from call (as a writer) = uHS ­ Cu Payoff at end of 1 year (if price of stock drops d times) = Value of stocks – payoff from call (as a writer) = dHS ­ Cd Option Pricing Option Pricing ­ Binomial Option Pricing Model where: H = hedge ratio S = stock price at time 0 C = Call price at time 0 u = 1 + % increase in stock price d = 1 ­ % decrease in stock price Cu = Call price when stock price rises u times Cd = Call price when stock price drops d times Option Pricing Option Pricing ­ Binomial Option Pricing Model To obtain a Hedged Portfolio: Payoffs at end of 1 period must be the same for the 2 possible stock prices ($30 or $50): uHS – Cu = dHS – Cd H = (Cu – Cd) / [(u – d) S] Option Pricing Option Pricing ­ Binomial Option Pricing Model Applying to the...
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