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Alenkinab [10]
3 years ago
13

34. Consider a binary (digital) option on a stock currently trading at $100. The option pays a $1 if the stock price goes below

$100 three months from now. The annualized standard deviation of the stock is 20%, and the risk-free rate is 0%. Suppose you sold a 100 of these binary options. How many shares of the underlying stock you need to long/short to achieve a delta-neutral position
Business
1 answer:
Vladimir [108]3 years ago
3 0

Answer:

48

Explanation:

N(d2): probability of call option being exercised

So current stock price = 100

K strike price = 100

r risk free rate = 0% = 0.05

s: standard deviation = 20%

t: time to maturity = 3month = 0.25 year

di – In(So/K) + (r +0.5 * 5%) ** S*t0.5

d1 = 0.05

d2 = dl - 5*10.5

d2 = -0.05

N(d2) = normsdist(d2) = 0.48

Pay-off per option = 1

No. of options sold = 100

Expected pay-off = -0.48*1*100 = -48

Therefore go long on 48 shares so that if stock price becomes 101, pay-off from stocks = 48*(101-100) = 48

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