Sign up  |  Log in

Payoff with Long position

Identify the trading strategy that will generate the payoffs of taking a long position in a call option within a single-period binomial framework.

  1. Buy h = (c+ + c)/(S+ + S) units of the underlying and financing of –PV(–hS + c)

  2. Buy h = (c+ – c)/(S+ – S) units of the underlying and financing of –PV(–hS + c)

  3. Short sell h = (c+ – c)/(S+ – S) units of the underlying and financing of +PV(–hS + c– )

The answer says at time 0 Buy -C and Buy -hS… should he be writing hS ( to hedge against the buy)?

Pg 382

The best just got better. Schweser's upgraded content and redesigned study platform are exactly what you need to pass the Level III exam. Save 10% when you preorder a Premium Package for a limited time.

Ques is asking us to replicate the pay off of a long call position. We would need to buy a share to replicate long call position and finance it with borrowing. If ques would have ask us to calculate arbitrage profit, what you r saying would have been right.  Hope this helps.

I came across this example as well (Example 1 page 382 Long Call Option Replicated with Underlying and Financing) and I am still trying to get my head around this concept. 

It appears answer A and B are identical. 

I believe what is being asked in my own words “What response below is the equivalent to buying a call option?” 

  1. Buy h = (c+ + c)/(S+ + S) units of the underlying and financing of –PV(–hS + c)

  2. Buy h = (c+ – c)/(S+ – S) units of the underlying and financing of –PV(–hS + c)

  3. Short sell h = (c+ – c)/(S+ – S) units of the underlying and financing of +PV(–hS + c– )

More or less just trying to talk this one through and see if I can better understand. 

What is the difference between response A and B in the above question?