The Nelson Company has $1,620,000 in current assets and $540,000 in current liabilities

A put has a strike of S18. At expiry, the underlying asset of this put is expected to be either $25 or $10. Use the one-step binomial pricing model to calculate the premium of this put when the return is 1.05 and the upstate risk-neutral probability is 0.59.

Expert Solution

Return is 1.05, Risk-neutral probability is 0.59, and Strike Price is $18.

We have a put option so we will exercise the option when the Underlying asset is less than the Strike price which is $18, so we will exercise it when the underlying asset is $10.

The payoff for the Put option = Strike price - Underlying asset price

Payoff for Put option = $18 - $10

Payoff for Put option = $8

Calculation according to the One-Step Binomial Pricing model is as follows:

Premium of Put Option = (Payoff * Probability)/ Return

Premium of Put Option = ($8 * 0.59)/ 1.05

A premium of Put Option = $4.495238 or $4.50

Hence, the total premium of the put option is $4.50.

Junaid answered 2 years ago

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