Question

A call option has an exercise price of $50. At the final exercise date, the stock price could be either $25 or $75. Which investment would combine to give the same payoff as the stock? Lend the present value (PV) of $25 and buy two calls. Lend the present value (PV) of $25 and sell two calls. Borrow $25 and buy two calls. Borrow $25 and sell two calls.

Answer 1

Hello Sir/ Mam

YOUR REQUIRED ANSWER IS OPTION A : Lend the PV of $25 and buy 2 calls

Given that:

At final exercise date, the final payoff could either be $25 or $75, hence, keeping in mind all the payoffs, we will lend the PV of $25, so as to receive $25 compulsorily and if, the price goes to 25, we'll have $25, and if it comes to $75, we will have $50 from option profit and $25 as maturity of loan, hence, replicating the payoffs,

I hope this solves your doubt.

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