Assume aone-period put optionwith Strike price is $100, the current stock price is S=$100 and the stock can increase or decrease in price by 10%. The risk-free rate is r=5% (per period), R= 1+r and the risk-neutral probability of an "up" move in the stock price is q = (R-D)/(U-D).

a). Use the BOPM to show that the fair price for the put is around 2.4 and explain the connection between the BOPM and risk-neutral valuation.

b).If all puts have a quoted price of Pq= 2.0 show how you can make a riskless arbitrage profit.

Answer rating: 100% (QA)

a Using the Binomial Option Pricing Model BOPM to calculate the fair price of the put option Given S... View the full answer