Consider the Level 3 outperformance option with a multiplier, discussed in Section 16.2. This can be valued binomially using the single state variable SLevel 3/SS&P, and multiplying the resulting value by SS&P.
a. Compute the value of this option if it were European, assuming the Level 3 stock price is $100, the S&P index is 1300, and the volatilities and dividend yields are 25% and 0 for the Level 3 and 16% and 1.8% for the S&P. The Level 3-S&P correlation is 0.4 and the option has 4 years to expiration.
b. Repeat the valuation assuming the option is American.
c. In the absence of a multiplier, would you expect the option ever to be earlyexercised? Under what circumstances does early exercise occur with the multiplier?