- Identify the trading strategy that will generate the payoffs of taking a long position in a call option within a single-period binomial framework.
A. Buy h = (c+ + c–)/(S+ + S–) units of the underlying and financing of – PV(–hS– + c–)
B. Buy h = (c+ – c–)/(S+ – S–) units of the underlying and financing of – PV(–hS– + c–)
C. Short sell h = (c+ – c–)/(S+ – S–) units of the underlying and financing of +PV(–hS– + c–)
B is correct.
- Identify the trading strategy that will generate the payoffs of taking a long position in a put option within a single-period binomial framework.
A. Short sell –h = –(p+ – p–)/(S+ – S–) units of the underlying and financing of –PV(–hS– + p–)
B. Buy –h = (p+ – p–)/(S+ – S–) units of the underlying and financing of –PV(–hS– + p–)
C. Short sell h = (p+ – p–)/(S+ – S–) units of the underlying and financing of +PV(–hS– + p–)
A is correct
Question:
- For Q1, why is the sign before PV negative? aren’t we borrowing → cash inflow so it should be +PV ?
- For Q2, same question: shouldn’t we short sell +h not -h?
- Is the term financing means either borrowing or lending?
My main issue is the signs before the terms. I thought short selling h shares means directly " -hS " , so in Q2 when we say " short selling -h " , I think of it (-)*(-)h , meaning +h, meaning we buy h shares.
I definitely have something mixed up, if you can help please !