Question

1. Consider the following discrete time one-period market model. The savings account is given by Bo 1 and B1 1.1. The stock price is given by So 1 and S,-ξ where ξ is a random variable taking two possible values u 1.2 and d = 0.9. Consider a put option whose payoff at time l is P = (1-S)+. (a) Find a replicating strategy for this option. By considering the value of the replicating strategy, find the time 0 price of the put option Po (b) Find the price Po using a second method via the Equivalent Martingale Measure (EMM).

Answer 1

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