Question

consider an american put option. the time to maturity is 2 years. we adopt a two-step binomial tree, with each step equals to one year. moreover, in each time step, the stock price either moves up by 20% or moves down by 20%. the strike price of the option is $52. the current stock price is $50. the risk-free interest rate is 7% per annum in continuous compounding. the continuous dividend rate is 2% per annum. calculate the price of the american put option

Answer 1

To calculate the price of the American put option, use the binomial pricing model to calculate option prices at each step and then find the discounted expected value.

Step-by-step explanation:

To calculate the price of the American put option, we can use the binomial pricing model. In each time step (year), the stock price either moves up by 20% or moves down by 20%. We start at the current stock price of $50 and calculate the stock prices at each step. The risk-free interest rate is 7% per annum in continuous compounding and the continuous dividend rate is 2% per annum.

Using the binomial pricing model, we can calculate the option price at each step by comparing the exercise value (the difference between the strike price and the stock price) and the expected option values at the subsequent nodes. The final option price is the discounted expected value of these option prices. By calculating this for the put option at each step, we can find the price of the American put option.