Question

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A stock is currently priced at $77.00. The risk free rate is 3.2% per annum with...

A stock is currently priced at $77.00. The risk free rate is 3.2% per annum with continuous compounding.

Use a one-time step Cox-Ross-Rubenstein model for the price of the stock in 15 months assuming the stock has annual volatility of 19.4%. Compute the price of a 15 month call option on the stock with strike $81.00.

Expert Solution

Parameters of Option Binomial Model –

There are three parameters of Option Binomial Pricing Model

up factor (u)
down factor (d)
probability (P)

up factor and down factor used to calculate rise in price and fall in price of underlying assets in one period. Probability is measure probability of rise in price and (1-P) is probability of price fall.

Cox-Rox-Rubinstein has suggested following formula to calculate these factors,

where,

u = Price up factor

d = Price down factor

P = Probability

t= time in a period

= volatility

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Thus, Price of 15 month European Call option is $5.79

jeff jeffy answered 5 months ago

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