Question

Given the maturity of an American put option 2 years, riskfree rate 10%, volatility of the stock 40%, current spot price of stock $50, strike price $50, what is the value of option when stock price is 96.084 in step 2, considering a 3-step binomial tree?

	A.	6.291
	B.	13.931
	C.	10.204
	D.	0

Answer 1

Answer of the above question is given below.

Determining Stock Prices

To agree on accurate pricing for any tradable asset is challenging—that’s why stock prices constantly change. In reality, companies hardly change their valuations on a day-to-day basis, but their stock prices and valuations change nearly every second. This difficulty in reaching a consensus about correct pricing for any tradable asset leads to short-lived arbitrage opportunities.

But a lot of successful investing boils down to a simple question of present-day valuation– what is the right current price today for an expected future payoff?

Binominal Options Valuation

In a competitive market, to avoid arbitrage opportunities, assets with identical payoff structures must have the same price. Valuation of options has been a challenging task and pricing variations lead to arbitrage opportunities. Black-Scholes remains one of the most popular models used for pricing options but has limitations.1

The binomial option pricing model is another popular method used for pricing options.

So this will be option c 10.204.