Replicate the option payoff

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Reference no: EM133578840

Question

Consider the price of a stock that either moves up 17% or moves down 13% with equal probability every year. Part of the compensation of the CEO of this company is 150,000 3-year call option contracts on the stock price. The strike price of each option contract is $115. This stock has no options in the market. The CFO must design a portfolio (stock, risk-free bond) to replicate the payoff of the options. Assume that the risk-free rate is flat at 4%, and the current stock price is $100. Use annual binomial trees.

How many shares of the stock the CFO must hold every year to replicate the option payoff?

Reference no: EM133578840

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