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A stock price is currently $100. Over each of the next two six-month periods it is...

A stock price is currently $100. Over each of the next two six-month periods it is expected to go up by 10% or down by 10%. The risk-free interest rate is 8% per annum with continuous compounding. What is the value of a one-year European call option with a strike price of $100 using a two-step Binomial tree? (Draw the tree)

Expert Solution

Solution:- Given in Question-

Stock price (Current Market price) = $100

Excersice price = $100

Call option is excersice when Current Market price on expiry is greater then Excersice price.

Bionomial Tree are shown in diagram-

Calculation of Probability-

First 6 Months-

Probability =

Probability = 0.704

(1-Probability) = 1 - 0.704 = 0.296

Next 6 Months-

Probability =

Probability = 0.704

(1-Probability) = 1 - 0.704 = 0.296

Value of one year Call option as on today = $10.408 * e-0.08 * 1

Value of one year Call option as on today = $10.408 * 0.9231

Value of one year Call option as on today = $9.608

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jeff jeffy answered 1 year ago

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