Question

A stock selling at $50 will either go up 20% or go down 10% each month...

A stock selling at $50 will either go up 20% or go down 10% each month for the next 3 months. The risk-free rate is 12% per annum with continuous compounding. Assume that a European put option is available for a strike price of $55 and a maturity of 3 months.

a. Use a 3-step binomial model to calculate the price of the put option.

0 0
Add a comment Improve this question Transcribed image text
Answer #1

q=e(-rt)-d/u-d

Here u=1.2 , d=0.9 ,x= 50 r=.12 t=.25(3/12) strike price=55

so q=e(-(.12*.25)-.9/12-.9

=e(-.03)-.9/.3

=.97044-.9/.3

=.2348

Value of put option at point 2

p2=e(-rt)*(p*Pupup + (1-q)Pupdwn)

p= price of put option

At Pupup:
50*1.2*1.2=72 so Pupup=0(more than strike price)

At Pupdwn:
50*1.2*.9=54 so Pupdwn=1(55-54)

At Pdwndwn:
50*.9*.9=40.5 so Pdwndwn=14.5(55-40.5)

So
p2=.97044*(.2348*0+(1-.2348)*1)

= 0.74258
p3=.97044*(.2348*1+(1-.2348)*14.5)

=10.995

So value of put option is :
=.97044*(.2348*0.74258+(1-.2348)*10.995)
=.97044(0.1743+8.413374)
=.97044*8.5877
=8.3338
=8.34

Add a comment
Know the answer?
Add Answer to:
A stock selling at $50 will either go up 20% or go down 10% each month...
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for? Ask your own homework help question. Our experts will answer your question WITHIN MINUTES for Free.
Similar Homework Help Questions
ADVERTISEMENT
Free Homework Help App
Download From Google Play
Scan Your Homework
to Get Instant Free Answers
Need Online Homework Help?
Ask a Question
Get Answers For Free
Most questions answered within 3 hours.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT