Consider a two-year European put option on Cat Corp shares. The current Cat Corp stock price is $1,000.00 and each year there is a 70% probability that the stock price will increase by 20% and a 30% probability that the stock price will decrease by 20%. The option has a strike price of $1,000.00 and the underlying of each option is one Cat Corp share. The risk-free interest rate is 10% per annum and the stock is not expected to pay any dividends over the next three years. Use a two-period binomial model.

(a) What is the value of the option at the end of first year assuming the stock price increases in the first year ?

(b) What is the current value of the option ?

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To value the twoyear European put option using a twoperiod binomial model we can follow these steps ... View the full answer