You use the following information to construct a binomial forward tree for modeling the price movements of
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You use the following information to construct a binomial forward tree for modeling the price movements of a stock.
(i) The length of each period is 4 months.
(ii) The current stock price is 100.
(iii) The stock’s volatility is 30%.
(iv) The stock pays no dividends.
(v) The continuously compounded risk-free interest rate is 8%.
Let PI be the price of a 95-strike 1-year European put option on the stock, and PII be the price of an otherwise identical American put option.
Calculate PII − PI.
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