You work on a proprietary trading desk of a large investment bank, and you have been asked for a quote on the sale of a call option with a strike price of $50 and one year of expiration. The call option would be written on a stock that does not pay a dividend.
From your analysis, you expect that the stock will either increase to $70 or decrease to $35 over the next year. The current price of the underlying stock is $50, and the risk-free interest rate is 4% per annum.
a. Briefly describe the steps involved in applying binomial option pricing model to value the call option in this situation.
b. What is this fair market value for the call option under these conditions?

  • CreatedDecember 17, 2014
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