Binomial Option Pricing Model - Calculating n

Don’t know if this is an error? Chapter 56, EOC Q #3 & 5 seem to have different formulas in the answer key for calculating n on puts:

Q3: n=(p+ - p-)/(S+ - S-)

Q5: n=(p- - p+)/S+ - S-)

Anyone understand this formula enough to say if this is just an error? For calls and in the text it looks like it should be the first.

there is no error.

question 3 is creating an arbitrage profit by selling 10 000 puts and shorting the delta amount of share. so the formula is reverse.

question 5 want to hedge is LONG position in puts, to hedge a position of long puts, you need to buy delta share in order to reverse the profit you make in the put position. so you need a positive delta.

don’t worry about the p+ - p- side, just worry about what you want to hedge. a long put or a short put?

good luck

Thanks…I know it doesn’t change the absolute # but it changes the sign. I thought for Q3 we both shorted the put and shorted the shares because it was negative.

Honestly, I was confused by this as well. I ended up just using the same formula for all of them, then stepping back and looking at the hedging situation. ie: you know that if you are LONG the puts, the hedge would be BUYING the underlying stock. But that’s just me…

What you need to do – look at the Put Call Parity …

In its standard form

P + S = C+X/(1+r)^T

So if you are short a Call you must be long a Stock -> they are on opposite sides of the equation.

If you are Long a Put, you should also be Long a Stock (Same side of the equation).