The binomial model builds on a simple idea: Over a given period of time, the asset’s price will either go up (u) to S 1 u > S 0 or go down (d) to S 1 d < S 0. We do not need to know the future price in advance, because it is determined by the outcome of a random variable. The movement from S 0 to either S 1 u or S 1 d can…
Combining the synthetic asset with the put–call parity relationship—so, substituting the present value of F 0(T) for S 0 in Equation 1—we have what is referred to as put–call forward parity.
Forward commitment replication was shown in earlier lessons to involve borrowing at the risk-free rate to purchase the underlying in the case of a long position or selling the underlying short and lending the proceeds at the risk-free rate for a short position. We also showed that a long underlying position combined with a short…
Value of the Underlying Exercise Price
