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(a) A bank has sold call options on 100,000 FBU shares for $180,000. FBU stock is trading at $15 per share, the option strike price
(a) A bank has sold call options on 100,000 FBU shares for $180,000. FBU stock is trading at $15 per share, the option strike price is $16, the maturity is in 3 months, and the stock volatility is 20% p.a.. FBU does not expect to pay dividends. Suppose that the risk-free rate is 5% p.a. (c.c.) and the bank has always been using continuous time model, how does the bank delta hedge? Specify whether the bank should use a long or short position to delta hedge. (6 marks)
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