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Answer: The strategy necessitates adjustments throughout the option's life based on the probability of exercise.
**Explanation:** - **Option A** is correct because the non-linear payoff profile of an option requires dynamic adjustments to the replicating transaction as the likelihood of exercise changes. Unlike forward commitments, which have constant replicating trades, call options require adjustments over time based on the probability of exercise. - **Option B** is incorrect. While it describes a step in the replication process if the option is exercised, the initial replication strategy involves borrowing at the risk-free rate to purchase the underlying asset, not selling it. - **Option C** is incorrect because a call option replication strategy does not involve a long forward contract. Instead, it requires borrowing at the risk-free rate to buy the underlying asset at inception.
Author: LeetQuiz Editorial Team
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Which of the following statements is most accurate regarding a call option replication strategy?
A
The strategy necessitates adjustments throughout the option's life based on the probability of exercise.
B
If the call option is exercised, the strategy involves selling the underlying asset and using the proceeds to repay the loan.
C
At inception, the strategy entails entering into a long forward contract on the underlying and borrowing at the risk-free rate.
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