## Price of Option...

d2syh
Good Student
Posts: 21
Joined: Fri Aug 17, 2012 3:27 pm

### Price of Option...

A 6-month American put option with a strike price of \$42 has an underlying stock which is trading at \$40. In 3 months the stock either moves up by 10% or down by 10%. The risk free interest rate is 6%. Determine the price of the option.
a. \$2.82
b. \$3.00
c. \$3.08
d. \$3.26

p = (erT – d)/(u – d) = 0.5756
F = e-rT[1.0034*0.5756 + 6*0.4244] = 3.08

Thanks.

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swarnendupathak
Finance Junkie
Posts: 119
Joined: Mon Sep 17, 2012 11:06 am

### Re: Price of Option...

It is tricky... see this is an American PUT option & not an European PUT. So at each node we need to consider the value higher of the two (a) value as per binomial mopdel or (b) simple the intrinsic value. As in the node 2 after 0.25 years when the price is Rs. 36, the value as per model is Rs. 5.37 but intrinsic value is Rs. 6 i.e. (42-36), so we need to consider Rs. 6 instead of Rs. 5.37.
This will give Rs. 3.08 at the final node.

Swarnendu

balajismz
Finance Junkie
Posts: 63
Joined: Mon Nov 05, 2012 9:13 am

### Re: Price of Option...

Reckon we dont have American options valuation in the Core readings??

Balaji

AMITAG1990
Finance Junkie
Posts: 89
Joined: Sat Sep 22, 2012 12:35 pm

### Re: Price of Option...

please any 1 can tell me,in above equation, from where the value 1.0034 came..??