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Homework - 3
Homework - 3
SoftID:2292119
Homework -3
Solution.
a) The binomial tree of possible future values in 4 weeks are described below:
93.01192
89.71806
86.54086 86.54086
83.47616 83.47616
80.52 80.52 80.52
77.66852 77.66852
74.91803 74.91803
72.26494
69.7058
b)
The value of p for the futures contract is calculated using the formula:
u and d are the factors by which the price increases and decreases(1.0367 and 0.9646)
By substituting all values in above equation we get value of p for the futures contract is
0.4957.
c)
The value of the European call option on June WTI is determined by constructing a binomial
payoff:
12.0119195
8.70968598
5.65433701 5.54085601
3.45148116 2.71787422
2.025545
3 1.33315868 0
0.65393462 0
The value of the European call option at expiration (Week 4) is approximately $2.0255.
The value of an American call option is generally higher than a European option because it can
be exercised early by calculating it is coming to around $2.0880.
The delta of the American call is approximately 0.48204, which means that for every $1 change
in the futures price, the option's value will change approximately $0.48204.
To hedge a long position in the call, I need to hold 0.48204 June futures.
My futures position for hedging is long.
To replicate a short position in the call, I need to hold -0.48204 contracts.
My futures position for replicating is short.
d) The value of the European put option on June WTI is determined by constructing a
binomial theorem is $1.67.
0
0
0
0.53678882 0 0
1.67473469 1.0555827
2.77554733 2.07577877
4.43984802 4.08197054
6.72858891
9.29419849
0
0
-0.175321 0
- -
0.3854852 0.3574222
- -
0.6041205 0.7286669
-
0.8610596
-1
To hedge a long position in the put, we need to hold -0.3854852 June futures.
To replicate a short position in the put, I need to hold 0.3854852 contract
My future position for replicating is long.