Question

A call option with an exercise price of $110 has six months to the expiration date. Currently, the stock is sold at a price of $120. At the expiration date, the underlying stock has two possible ending prices: $150 or $105. The risk-free rate of return is 8 percent per annum. Calculate the price of this call option using binomial option pricing model. (Hint: You can use any of the two methods of your preference)

Answer 1

Solution:-

Assume Continuous Compounding.

First we need to Find Probability-

Probabilty for upward Movement =

Probabilty for upward Movement =

Probabilty for upward Movement = 0.4422

Probabilty for Downward Movement =1 - Probabilty for upward Movement

Probabilty for Downward Movement =1 - 0.4422

Probabilty for Downward Movement = 0.5578

Option Price of call as on Today
		A	B	A*B
Current Market Price as on Expiry	Excersice Price	Option Price as on Expiry	Probability	Expected Option price as on expiry
150	110	40	0.4422	17.688
105	110	0	0.5578	0
				17.688

Price of this Call Option =

Price of this Call Option =

Price of this Call Option = $17

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