A binary option pays off $150 if a stock price is greater than $40 in three months.

A binary option pays off $150 if a stock price is greater than $40 in three months. The current stock price is $35 and its volatility is 35%. The risk-free rate is 4% and the expected return on the stock is 10%.

3.1 What is the value of the option?
3.2 What is the real-world probability that the payoff will be received?

Solutions

Expert Solution

Given:

Current stock price = 35
expected return = 10%
Volatility = 35%
risk free rate = 4%

The probability distribution of is

Since

the probability of the stock price being above $40 in 3 months time =

3.1. value of the option = 0.3078*4150 = $46.17

3.2. real-world probability that the payoff will be received = 0.3078

jeff jeffy answered 2 years ago

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