One Period Binomial Model

CFA Level II Derivatives
#1

wiley, Reading 41, lesson 1 (pg 167)

If you write/sell/short a call option and go long on the underlying stocks the value of the portfolio is:

H = hS - c

H = value of portfolio

h- Hedging ration

C = value of call option

  1. Why do you subtract the value of the call option here?

  2. If you were writing the call option wouldn’t that be equal to an inflow of capital equal to the value, from the purchaser of the call option?

Thanks for any help!

#2

hS -c = Short (hedge ratio * underlying) and long a call option. The hedge ratio is just the delta.

1.The notation is terrible. You are not subtracting the call value, it means you are long the call i.e there has been a cash outflow. You have bought the call and spent money to pay the premium.

Correct if you were selling a call option you would have a cash inflow, but that is not what the above is showing.

#3

That makes much more sense… Thanks!