Chapter 03 · Section 3.1

Binomial Pricing Question 2

Stock XYZ costs 110. There is a call option and a put option listed on this stock, both with an exercise price of 100. There is a 50% probability that the stock could go up to a level of 143 and a 50% probability that the stock could go down to a level of 99. The risk free interest rate is 10%. Given these hypotheses, what should be the current value of the call?

a) -21.50
b) -1
c) 24
d) 1/19.53
• e) +19.54
  Yes. There is the same probability that the value of the call at the end of the following period will be 43 or 0. Discounting the option value by a 10% interest rate, the call's value is (1/1.1) x {(0.5 x 43)+(0.5x0)) =19.54. Continue
  f) 0

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