Binomial Model (Deriv) Question...

Hi All,

In my Schweser books, I have them giving us the Size of Up-move being 1.15.

The down move is thne said to be 1 / Up move = 0.87.

Easy enough.

Then in the CFA book, the question said that the stock price can go up by 10 percent or down 15 percent. If you do 1 / 1.10 = 0.90.

WHat I should have used is just 1.10 and 0.85, and not did the 1/ up move formula. Do you only use this formula if they do not tell you the down move amount?


I remember that question and thought it was BS. I don’t recall any examples from CFAI problems where you had to derive the U or D movement percentage. On the exam I would use them if they are given but if not then use that formula to derive the rate.

and what the hell is this “hedging ratio” that the CFAI book is talking about.

The put price today is 12.78

If the currnet put price is $14.

We should sell the sell and short the underlying stock, The hedge Ratio is

n = P+ - P- / S+ - S-

This formula is just the binomial tree results.

gives us -0.3125. FOr every option sold, we should sell 0.3125 shares of stock. If we sell 10,000 puts, we should sell 3,125 shares of stock.

Derivs are terrible… im hoping that just ask a lot of qualitative questions about BSM and CDS.