Question

Consider a two-period binomial model, where each period is 6 months. Assume the stock price is $46.00, o=0.28, r=0.06 and the dividend yield is 2.0%. What is the maximum approximate strike price where early exercise would occur with an American call option at point Su? Assume that the strike price K is a whole number

Answer 1

In a two-period binomial model, the maximum approximate strike price where early exercise would occur with an American call option at point Su is $47.84.

Step-by-step explanation:

In a two-period binomial model, the maximum approximate strike price where early exercise would occur with an American call option at point Su can be found by comparing the intrinsic value of the option at each node in the binomial tree. At point Su, we can calculate the intrinsic value by subtracting the strike price from the stock price. If the intrinsic value is positive, early exercise would occur. Therefore, we need to find the strike price where the intrinsic value at point Su is zero.

Using the given information, let's calculate the stock price at point Su. The stock price at Su is given by:

Su = S * u = $46.00 * (1 + r - dividend yield) = $46.00 * (1 + 0.06 - 0.02) = $46.00 * 1.04 = $47.84

Now, we can calculate the maximum approximate strike price by setting the intrinsic value at point Su equal to zero:

$47.84 - K = 0

Solving for K, we get:

K = $47.84

Therefore, the maximum approximate strike price where early exercise would occur with an American call option at point Su is $47.84.