Testing the Technology of Synthetic Straddles
18 Pages Posted: 27 Apr 2014
Date Written: April 26, 2014
A model of building and using synthetic straddles has been developed; it enables an investor to significantly reduce its individual equity risk related to its own basic assets, i.e. shares. The Black-Scholes model, which is regarded as a classical model, cannot be used for this purpose for the reason that a synthetic straddle provides for investor's combining a share under review and a risk-free bond in its portfolio, whereas the Black-Scholes model contains a risk-free interest rate only, but no risk-free bond. Therefore, to build a synthetic straddle, a binomial model is used. Such model takes account of straddle price variance according to regression forecast model. It is shown that the model is effective even in the context of shocking phenomena in the country's economy provided that an investor immediately responds to them.
Keywords: synthetic financial instruments, option, straddle, share risk
JEL Classification: C15, C22, G11, G12, G17
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