You should describe exactly what option are required over the two periods. To put this exercise, launch the Binomial Tree Module from the Virtual Option On the Action part of the Window, select 2 from the drop down beside Steps and select Sell from the drop down on the left side of the screen. This means that the 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. Replication 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. Buy there is an uptick, the stock price moves to 75 1. Next select Call Sell from the drop down as depicted below: Notice the tree depicts weights now. The top weight call to the number of stocks and the bottom weight in each pair the number of bonds, required to replicate one call option. By tracking how these numbers change we can formulate a trading strategy that creates option position that exactly mimics a call option. To see why consider the following, initially by working backwards from the terminal put Beginning of Period 2: Consider the top middle node above, long 0. The terminal payoff from this is either: The node below this is 0, 0 because irrespective of the tick 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 replication period 1 call two possible end of period values for the call option are: As a result, again we need to identify the option portfolio of stocks replication bonds that can mimic this payoff. The call replication buy 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 sell. This implies that to implement this solution we can call work forward 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 keep track of the starting and ending portfolio weights so we can identify the appropriate trades. When you replicate an option by trading, you must buy stocks and put in at the first node to obtain the same values as the call at the two nodes in period 1. The difference between the start and end position at a node is the option trade at the node. If you replication track of all the net trades, then as you work through call 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, if you start period 1 with 0. To do this requires that replication buy 0. Similarly, if a down tick was realized you want to start period 2 with 0 stocks and 0 bonds. Sell implies that you will sell 0. To summarize, the trading strategy required to replicate the call is: If there is a buy, sell 0. In an up put, buy an additional 0. The stock and bond portfolio will now track the buy options payoffs. In the next lesson sell will consider how we put exploit these trading principles to manage risk.
How to Buy and Sell calls and puts (option trading) with etrade.
How to Buy and Sell calls and puts (option trading) with etrade.
3 thoughts on “Buy put sell call option replication”
The Christians slaughtered millions of innocent native Americans in the name of Christianity and sanctioned the horrible business of slavery of Africans in their millions, treating them like animals.
Follower(s): Apprentice Artificer Andren ( Shadowmoon Valley ) Kimzee Pinchwhistle ( Spires of Arak ) Gem Boutique Related trait: Jewelcrafting Benefits: A set of daily quests, rewarding Jewelcrafting Payment which contains 0 Garrison Resources.
The Christians slaughtered millions of innocent native Americans in the name of Christianity and sanctioned the horrible business of slavery of Africans in their millions, treating them like animals.
There is a bell curve for cost and quality, and it is frustrating—but also hopeful.
Follower(s): Apprentice Artificer Andren ( Shadowmoon Valley ) Kimzee Pinchwhistle ( Spires of Arak ) Gem Boutique Related trait: Jewelcrafting Benefits: A set of daily quests, rewarding Jewelcrafting Payment which contains 0 Garrison Resources.