A stock is trading for $75 in the spot market. The continuously compounded risk-free interest rate is equal to 1% per annum. At-the-money options on this stock with 1.5 years to maturity trade at an implicit volatility of 50%. Using a 4-period binomial lattice, and the traditional approach, calculate the price of a plain vanilla put option on this stock in the following situations:

A) The stock will pay no income during the option's life and the option is of European style.

B) The stock will pay no income during the option's life and the option is of American style. Spell out the value of the option's early exercise privilege.

C) The stock will pay dividends at a continuous rate of 3% per annum during the option's life and the option is of American style. Calculate the value of the option's early exercise privilege.

D) The stock's current dividend yield is equal to 3% and the dividend will be paid in one installment in exactly one year. The option is of American style. Calculate the value of the option's early exercise privilege.

Answer rating: 100% (QA)

ANSWER A To calculate the price of a plain vanilla put option we need to construct a binomial lattic... View the full answer