Consider a European put option on a non-dividend paying stock with a strike price $56 and expiration
Question:
Consider a European put option on a non-dividend paying stock with a strike price $56 and expiration in 8 months. The current stock price is $55. The stock's volatility is 15%. Over each of the next two 4-month periods the stock price is expected to go up by 9% or down by 8%. The risk-free interest rate is 6% per annum with continuous compounding for all maturities.
(a) Use a two-step binomial tree to calculate the value of this European put option. Show your step-by-step workings. [10 marks] Note: No need to draw a binomial tree in the answer field. Just show your calculations.
(b) Use the Black-Scholes-Merton model to calculate the value of this European put option. Show your step-by-step workings. [9 marks]
(c) If this option is an American option rather than an European option (all else staying the same), briefly describe how you will value this option (no calculations needed) and why. [3 marks]
Introduction To Derivatives And Risk Management
ISBN: 9781305104969
10th Edition
Authors: Don M. Chance, Robert Brooks