Tutorial Five (Week beginning Monday 1^st November 2021)

Problem (ii)

Explain the risk neutral and the no-arbitrage valuation approaches to valuing an option using a one-step binomial tree.

Problem iii

Consider a European put option on a non-dividend-paying stock where the stock price is 2.50, the strike price is 2.50, the risk-free rate of interest is 2% per annum, the volatility is 20% per annum, and the time to maturity is six months.

1. Calculate u, d and p for a two time-step binomial tree
2. Value the option using a two time-step binomial tree.
3. Calculate and interpret the delta and gamma option price sensitivities at the second time step

[Final exam, 2017]