Shares in XYZ Corporation sell today for $20. The risk-free rate is 3% (continuously compounded). In the next six months, XYZ shares will either increase in price by 30%, or decrease by 40%. In the following six months, XYZ shares will again either increase in price by 30%, or decrease in price by 40%. XYZ pays no dividends.
(1) What is the price of a European call with strike $19 and expiration in one year? Use abinomial tree.
(2) What is the price of a European put with strike $19 and expiration in one year? Use a binomial tree, and then verify your answer with put-call parity.
(3) Now obtain the prices of these call and put options using risk-neutral probabilities. Verify that you get the same answers as in (1) and (2).

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To solve this problem we can use a binomial tree approach to approximate the prices of the European call and put options Lets go step by step 1 Price of European Call using a Binomial Tree First we ne... View the full answer