Question
(a) Draw the payout profile for the following two call spread portfolios. (i) +1 K call and 1 (K + 1) call. (ii) +2 K
(a) Draw the payout profile for the following two call spread portfolios.
(i) +1 K call and â1 (K + 1) call.
(ii) +2 K calls and â2 (K + 0.5) calls.
(b) By constructing a series of portfolios of call spreads and taking limits, prove that the price at time t of a digital call, with strike Kâ and payout 1, is given by
(c) Write down the equivalent formula for a digital put option in terms of put prices.
(d) By examining the payout profile, derive a put-call parity relationship for the digital call and digital put.
k CK (t, T) |K*, where K* means the function is evaluated at K = K*.
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a To draw the payout profiles for the call spread portfolios we need to consider the scenarios where the underlying asset price at expiration T is eit...Get Instant Access to Expert-Tailored Solutions
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