Question

Sample Application $\mathrm{F}$ in the DerivaGem Application Builder Software considers the static options replication example in Section 26.17. It shows the way a hedge can be constructed using four options (as in Section 26.17) and two ways a hedge can be constructed using 16 options. (a) Explain the difference between the two ways a hedge can be constructed using 16 options. Explain intuitively why the second method works better. (b) Improve on the four-option hedge by changing Tmat for the third and fourth options. (c) Check how well the 16-option portfolios match the delta, gamma, and vega of the barrier option.

   Sample Application $\mathrm{F}$ in the DerivaGem Application Builder Software considers the static options replication example in Section 26.17. It shows the way a hedge can be constructed using four options (as in Section 26.17) and two ways a hedge can be constructed using 16 options.
(a) Explain the difference between the two ways a hedge can be constructed using 16 options. Explain intuitively why the second method works better.
(b) Improve on the four-option hedge by changing Tmat for the third and fourth options.
(c) Check how well the 16-option portfolios match the delta, gamma, and vega of the barrier option.

Options, Futures, and Other Derivatives

John C. Hull 10th Edition

Chapter 26, Problem 28

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Step 1

In the first method, the 16 options are all of the same type (e.g., all call options or all put options) and have the same strike price. In the second method, the 16 options are a combination of call and put options with different strike prices. Intuitively, the Show more…

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Sample Application $\mathrm{F}$ in the DerivaGem Application Builder Software considers the static options replication example in Section 26.17. It shows the way a hedge can be constructed using four options (as in Section 26.17) and two ways a hedge can be constructed using 16 options. (a) Explain the difference between the two ways a hedge can be constructed using 16 options. Explain intuitively why the second method works better. (b) Improve on the four-option hedge by changing Tmat for the third and fourth options. (c) Check how well the 16-option portfolios match the delta, gamma, and vega of the barrier option.

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