Which of the following terms directly represents the volatility of the underlying in the binomial model?
A. The standard deviation of the underlying
B. The difference between the up and down factors
C. The ratio of the underlying value to the exercise price.
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To determine the price of an option today, the binomial model requires:
A. selling one put and buying one offsetting call.
B. buying one unit of the underlying and selling one matching call.
C. using the risk-free rate to determine the required number of units of the underlying.
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.
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.
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