Should be fairly quick please show the work so i know the process. Thank You ! C
ID: 2493495 • Letter: S
Question
Should be fairly quick please show the work so i know the process. Thank You !
CIT Corp currently trades for $50 per share. It is expected with equal probability to either rise in price to $55 per share in one year or $75 per share in one year. Assume the binomial model for option contracts.
1) Assume you will build a portfolio consisting of one share of CIT Corp and one call option on CIT Corp with a strike price of $50 (for one share of stock). What is the hedge ratio for this portfolio?
2) What is the price of a call option for this portfolio assuming a 10% risk-free rate?
3) Using put-call parity, what must the price of a put option with a strike price of $50 be today assuming a 10% risk-free rate?
Explanation / Answer
1. HEDGE RATIO IS 0%. BECAUSE WE HAD PURCHASED ANOTHER CALL OPTION. BUT WE ALREADY HAVE ONE SHARE AND WE SHOULD BUY PUT OPTION TO HEDGE IT NOT CALL OPTION.
2. PRICE OF CALL OPTION = (($75 + $55) / 2) / 1.10 = $59.10
3. PRICE OF PUT OPTION = ($50 - ($50 X 0.909) = $4.55