For a two-period binomial tree with periods of 1 year:
(i) The increase in price of a call option from the initial node to the middle node at the end of the tree is 5.2.
(ii) The estimates of delta, gamma, and annual theta from the tree are .3, .124, and 1.125 respectively.
Determine the increase in stock price from the initial node to the middle node at the end of the tree.
I use the formula:
θ = (C_ud - C_u - Δ*ϵ -.5*(ϵ^2)*Γ) / (2h)
They set up the formula as so:
1.125 = (5.2 - .3*ϵ - .062*(ϵ ^2) ) / h
Then solve for ϵ.
Why are they using C_u = 0?
Thanks!
(i) The increase in price of a call option from the initial node to the middle node at the end of the tree is 5.2.
(ii) The estimates of delta, gamma, and annual theta from the tree are .3, .124, and 1.125 respectively.
Determine the increase in stock price from the initial node to the middle node at the end of the tree.
I use the formula:
θ = (C_ud - C_u - Δ*ϵ -.5*(ϵ^2)*Γ) / (2h)
They set up the formula as so:
1.125 = (5.2 - .3*ϵ - .062*(ϵ ^2) ) / h
Then solve for ϵ.
Why are they using C_u = 0?
Thanks!
Exercise 12.27 in ASM Manual
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