Question

A stock’s price is currently 53.75. Over each of the next two three-month periods it is expected to go up by 10 percent or down by 10 percent. The risk-free interest rate is 1.875 percent per annum with continuous compounding. What is the current value of a six-month European Put option with strike price of 53.25 using a two-step binomial tree? How will you trade to make profits if the put option’s current market price is 3.37, using one option in trading? Answer the following.

33.     Current fair value of put option.

34.     Value of delta at time zero.

35.     Value of delta at three months when the stock price is up.

36.     Value of delta at three months when the stock price is down.

37.     Net cash position (bank balance) at time zero.

38.     Net cash position (bank balance) at upper branch at time 3 months.

39.     Net cash position (bank balance) at lower branch at time 3 months.

40.     Net cash position (bank balance) at upper branch at maturity.

41.     Net cash position (bank balance) at middle branch at maturity.

42.     Net cash position (bank balance) at lower branch at maturity.

Answer 1