Question

In: Finance

A call option with an exercise price of $110 has six months to the expiration date....

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.

Solutions

Expert Solution

Solution:-

Assume their is Continuous Compounding method use.

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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