Beruflich Dokumente
Kultur Dokumente
Chapter 10
A stock price is currently $20 In three months it will be either $22 or $18
22 1
or
The riskless portfolio is: long 0.25 shares short 1 call option
Su u
Sd d
FIN 480 (Instructor- Saif Rahman)
Generalization (continued)
Su u
Sd d
d or
u Su
6
fd Sd
FIN 480 (Instructor- Saif Rahman)
Generalization (continued)
Su
(Su
u )erT
Generalization (continued)
Substituting for
we obtain
= [ p u + (1 p )d ]erT
where
e u
rT
d d
FIN 480 (Instructor- Saif Rahman)
Risk-Neutral Valuation
= [ p u + (1 p )d ]e-rT The variables p and (1 p ) can be interpreted as the risk-neutral probabilities of up and down movements The value of a derivative is its expected payoff in a risk-neutral world discounted at the risk-free rate
S
9
Su u
Sd d
FIN 480 (Instructor- Saif Rahman)
Since p is a risk-neutral probability -20e0.12 0.25 = 22p + 18(1 p ); p = 0.6523 Alternatively, we can use the formula
e rT d u d
0.6523
10
Sd = 18 d = 0
11
22
24.2 3.2
B E
20 1.2823
2.0257 18
C
0.0
Value at node B = e0.12 0.25(0.6523 3.2 + 0.3477 0) = 2.0257 Value at node A = e0.12 0.25(0.6523 2.0257 + 0.3477 0) = 1.2823
12
K = 52, t = 1yr r = 5%
60
50 4.1923
A
72 0
B
E
1.4147 40
C
48 4 32 20
9.4636
F
13
60
50 5.0894
A
B E
1.4147 40
C
12.0
F
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Delta
= Delta = Change in price of the option/Change in price of the stock = Number of units of the stock that are held for each call option shorted to create a risk free hedge
15
The value of
Choosing u and d
One way of matching the volatility is to set
u d e 1 u
t
where is the volatility and t is the length of the time step. This is the approach used by Cox, Ross, and Rubinstein
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for a stock index wher e q is the dividend for a currency where r f is the foreign