Assume a call option’s strike price is initially equal to the price of its underlying asset. Based on the binomial model, if the volatility of the underlying decreases, the lower of the two potential payoff values of the hedge portfolio:
A. decreases.
B. remains the same.
C. increases.
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Identify the trading strategy that will generate the payoffs of taking a long position in a put option within a single-period binomial framework.
A. Short sell $–h = –(p^+ – p^–)/(S^+ – S^–)$ units of the underlying and financing of $–PV(–hS^– + p^–)$
Buy $–h = (p^+ – p^–)/(S^+ – S^–)$ units of the underlying and financing of $– PV(–hS^– + p^–)$
C. Short sell $h = (p^+ – p^–)/(S^+ – S^–)$ units of the underlying and financing of $+PV(–hS^– + p^–) $
Hedging in the futures market
A. eliminates the opportunity for gains.
B. eliminates the opportunity for losses.
C. increases the earnings potential of the portfolio.
D. does all of the above.
E. does both A and B of the above.
Which of the following is not a factor in pricing a call option in the binomial model?
A. The risk- free rate
B. The exercise price
C. The probability that the underlying will go up
Which of the following best describes the binomial option pricing formula?
A. The expected payoff is discounted at the risk- free rate plus a risk premium.
B. The spot price is compounded at the risk- free rate minus the volatility premium.
C. The expected payoff based on risk- neutral probabilities is discounted at the risk-free rate.
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