The price of Alexion stock is $62 per share. The riskless interest rate for continuous compounding is 2% and the stock's volatility is 25%. Alexion stock does not pay dividends. 

(a) A put option on Alexion stock expires in six months, has a strike price equal to $65 per share, and is European exercise style. Using a binomial tree with two-time steps, what is the price per share of the put option? Use replication to answer this question. 

b) Suppose the option contract size is 100 shares of stock. Use your ∆ and B at each node of your binomial tree to describe the portfolio strategy that replicates the put option in part (a). In other words, what is your stock position at each node? 

How much should you borrow or lend at each node?  

How should you rebalance your portfolio at each node?

Answer rating: 100% (QA)

a To price the put option using a binomial tree with twotime steps we first need to determine the parameters of the tree Using the riskneutral probabi... View the full answer