Price of Option...

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Price of Option...

Postby d2syh » Wed Nov 07, 2012 3:33 pm

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.
Choose one answer.
a. $2.82
b. $3.00
c. $3.08
d. $3.26

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

My answer is a. Pls explain the correct answer.



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Re: Price of Option...

Postby swarnendupathak » Wed Nov 07, 2012 3:56 pm

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.


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Re: Price of Option...

Postby balajismz » Wed Nov 07, 2012 4:00 pm

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


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Re: Price of Option...

Postby AMITAG1990 » Wed Nov 07, 2012 9:02 pm

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

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