Assume that you are an options seller (e.g., a financial institution) who is selling a European Call option on Silver ETF (Silver Exchange Traded Fund). Assume that the underlying asset is Silver ETF with no storage cost and no dividend. The risk-free rate with continuous compounding is 4% per annum (i.e. r = 0.04). See information below:

STOCK/SPOT PRICE                                                                     So                $160

STRIKE PRICE                                                                                K                   $190                   

MAT DATE OF FORWARD CONTRACT (3 MONTHS)                    T              3/12(or 0.25)

VOLATILITY                                                                                     o                   60%

RISK-FREE RATE                                                                            r                    4%

DIVIDEND                                                                                          q                  0

[Risk-Neutral Valuation Approach] 

Based on the information above, apply the Risk-Neutral Valuation approach with one step binomial option pricing model and calculate the value of a European CALL option with an exercise/strike price of $190 (K = $190) and maturity of 3-month (T = 3/12 or 0.25). 

Note: your answers should show all of the complete steps 1 to 2 below; show all variables, formula, calculations, and results (for steps 1 and 2) as clear as possible: 

· Step 1 - calculation of "Risk-Neutral Probability (p)" with binomial tree of the option price 

· Step 2 - calculation of "Risk-Neutral Valuation" and final result of the No Arbitrage 

Option Price (based on the Risk-Neutral Valuation Approach). 

[Show your answers, formula, steps/calculations, and discussions as clear as possible]

Answer rating: 100% (QA)

To calculate the value of a European Call option using the RiskNeutral Valuation approach with a one... View the full answer