16. Use a three step tree to value a three month American put option on wheat futures. The current futures price is is 380 cents, the strike price is 370 cents, the risk-free rate is 5% per annum, and the volatility is 25% per annum. Explain carefully what happens if the investor exercises the option after two months. Suppose that the futures price at the time of exercise is 362 and the most recent settlement price is 360.

The answer is given: (Please show the detailed process!)

Value is 15.14 cents. Total gain from exercise after 2 months is 8 cents. there would be a 10 cent cash pay off and a short futures position worth -2 cents.

Please show the detailed process! Thanks!