Table of Contents
A. Binomial Model
A short call is an options position is a trading strategy when a trader believes that the price of the asset underlying the option will drop.
- When an investor sells a call option, the transaction is called a short call.
B. Risk-neutral valuation
The goal is to find the price for an option.
- Therefore we use a binomial model to find the price of the option.
The following portfolio is considered:
- Buy $H$ shares of the underlying asset
- Short $1$ call option
Hedge ratio – Tells the how much the payout for the options will change for a dollar change in the stock.
- Risk-neutral probability – is the probability that there would not be any risk in the portfolio.