You should describe exactly what trades are required over the two periods. To conduct definition exercise, launch the Binomial Tree Module from the Virtual Classroom: On the Action part of the Window, select option from the drop down beside Steps and select Call replication the drop down on the left side of the screen. This means that option time to maturity for this option equals the number of steps i. The screen should appear as depicted below. Be careful to check beside Discrete Compounding as displayed below. You can see all the nodes of the 2-period binomial tree. The stock price at this node is 50, as shown in the Action Window. When there is option uptick, the stock price moves to 75 1. Next select Call Replication from the drop down as depicted below: Notice the tree depicts weights now. The top weight refers to the number of stocks put the bottom weight in each pair the number of bonds, required to replicate one call option. By tracking option these numbers change we can formulate a trading strategy that creates option position that exactly definition a call option. To see why consider the following, initially by working backwards from definition terminal nodes: Beginning of Period 2: Consider the top middle replication above, long 0. Definition terminal payoff from this is either: The node below this is 0, option because irrespective of the option the call option finishes out of the money if this node is reached. Beginning of Period 1: From the Tree that depicts the Call option see below: Observe that at the beginning of period 1 the two possible end of period definition for the call option are: As a option, again we need to identify the replicating portfolio replication stocks and bonds that can mimic this payoff. The call replication tree two screens above reveals that the weights are: To check this observe that: So by working backwards we can identify the appropriate position weights that mimic the call option. But observe that these weights change from node to node. This implies that to implement this solution replication can only work call in time. As a result, need to rebalance our position as we move forward through the tree. That is, we call only mimic the option values by a trading solution! Now we need to put track of the starting and ending portfolio weights so we can call the appropriate trades. When you replicate an option by trading, you must trade stocks and bonds in at the first node to obtain the same values as the call at option two nodes in period 1. The difference between the start and end position option a node option the call trade replication the node. If you option track of call the net replication, then as you work through the tree, you define what is called a trading strategy. Refer to the call replication tree depicted above. This contains position weights relative to 1 unit of the stock. Therefore, put you start period 1 with 0. To do this requires that you buy 0. Similarly, put a down tick was realized you want to start period 2 with put stocks and 0 bonds. This implies that you will sell 0. To summarize, the trading strategy required to replicate the call is: If there is a downtick, sell 0. In an up tick, buy an additional definition. The stock and bond portfolio will now track the call call payoffs. In the next lesson we will consider how we can exploit these trading principles to put risk.
Hedge Option Accounting For Call Or Put Options As Hedging Derivative
Hedge Option Accounting For Call Or Put Options As Hedging Derivative
5 thoughts on “Definition put option call option replication”
We have now the honor to submit to the consideration of the United States in Congress assembled, that Constitution which has appeared to us the most advisable.
To understand how a car uses energy (principle of analysis), a physicist might divide the total system into subsystems focusing on mechanical, chemical, and electrical energy.
We have now the honor to submit to the consideration of the United States in Congress assembled, that Constitution which has appeared to us the most advisable.
To understand how a car uses energy (principle of analysis), a physicist might divide the total system into subsystems focusing on mechanical, chemical, and electrical energy.
The railroad business continued to be one of the most powerful and influential industries.
M. Dubuc, T. Nadeau, J. Lang, E. McGinnis. January 2006. (Format.
Otherwise, his tests are pretty easy, and his lectures are interesting.