Question

Consider a two-period binomial model, where each period is 6 months. Assume the stock price is $46.00, o=0.28, r=0.06 and the dividend yield is 2.0%. What is the maximum approximate strike price where early exercise would occur with an American call option at point Su? Assume that the strike price K is a whole number

Answer 1

TWO-PERIOD BINOMIAL MODEL

here each period is of 6 month

The stock price s0=$46.00

here the time is 1 year and divided in to 2period of 6 months each

here, the dividend yield=2.0%

after 6 month $\sigma$ =0.28

then in next 6 month r=0.06

after 6 month 0.28 decrease=$46.00*(0.28/100)=$46.00-0.128=$45.87

then in next 6 month 0.06 increase=$46.00*(0.06/100=$46.00-0.0276=$45.97

then the maximum strike price is=($45.87-$45.97 / 0.28 - 0.06)*2.0%=$ 2.367