(A) what postion would the investor need to take in the stock to hedge this post

Question

(A) what postion would the investor need to take in the stock to hedge this postion? (B) what js the value of each option usinf no-arbitrage arguments ? The current price of a non-dividend-paying stock is $50. Over the next six months it is expected to rise to $55 or fall to $47. An investor buys put options with a strike price o th 8) f $52. What position would e investor need to take in the stock to hedge this position? What is the value of each option using no-arbitrage arguments? The risk-free interest rate is 2% per annum with continuous compounding.

Explanation / Answer

(A)If investor is long(Bought) in the stock then shall go short(sell or put) in derivative and if he is Short in stock the go for long in the derivative to hedge th eposition. Thus, in the current scenerio , as investor buys put(short) option then he should go for buying (long) stock.

(B)

P = (52-47)/(55-47) =                   0.6 1-P =                   0.4 Risk free rate for 6 Months is 1% Value of call option; Situation Cash flow Probability Goes up 3 0.6 1.8 Goes down 0 0.4 0 1.8 Present value 1.8ert = 1.8e.01*1 1.82 Price of call option is $ 1.82 Put option: Situation Cash flow Probability Goes up 0 0.6 0 Goes down 5 0.4 2 2 Present value 2ert = 2e.01*1 2.02 Price of call option is $ 2.02

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