You go to lunch with financial guru W.B. In strictest confidence, he tells you that in 1 years time the E&R 500 stock index will be either at 2000 or at 2300 points. The index is currently at 2100. Acting upon this information and using the dichotomy (aka 1-level binomial tree) model, you price and sell 100 calls for the index at the strike E = 2180. In the call price, you include a $10 mark-up. Assume, for simplicity, that you have access to interest-free borrowing, i.e. r = 0. 1. What is the price at which you sell the calls (including the mark-up)?

2. Describe the hedging procedure you undertake. What is you total profit/loss if the index ends up at 2000? What is you total profit/loss if the index ends up at 2300?

3. If W.B. is wrong and the index ends up at 2320, what is your total profit/loss?

4. What do you think E&R stand for?.