## Question

# (b) A stock price is currently $100. Over each of the next two six-month periods it is expected to go up by 10% or down

(b) A stock price is currently $100. Over each of the next two six-month periods it is expected to go up by 10% or down by 10%. The risk-free interest rate is 8% per annum with annual compounding interest. (i) How would you strategize your hedging of a one-year European call option with a strike price of $80? Explain you answer and present them in a binomial model diagram.

(ii) With the value of call option calculated in (i) estimate the value of a one-year European put option that has the same strike price and the same expiration date.

Refer to the price quotes of Bursa Malaysia FTSE Option KLCI for May 2020 expiry month. Assuming that currently you are in April 2020, propose your trading strategy if KLCI is now trading at 1400 points based on your anticipation of the future.

Name open bid ask last done change

OKLI C 1370 UP MAY 2020 24 24 +4.3

OKLI B 1370 DOWN MAY2020 3.5 3.3 4 -0.3

## Step by Step Solution

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### Step: 1

Hedging Strategy for a European Call Option using the Binomial Model Lets break down the process stepbystep incorporating a binomial tree model for clarity Given Data Current stock price S 0 100 S 0 1...### Get Instant Access to Expert-Tailored Solutions

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