3 We can calculate the relative changes u,d in the binomial tree if we know the volatility and mean return of the stock. In this formulation, we are assuming the price movement as a logarithm process. To calculate the relative changes, we can use 1+U=et and 1+D=et In this process, we can calculate k(0,T)=ln(ST/S0) (Proposition 2.12 in the text). Price a 5 month call option where the =0.20,S0=62, expiration is 5 months, the strike, X, is 60 , and the annual rate of interest is 10% compounded monthly. - What is the risk-neutral probability? - Draw the entire tree showing all stock prices and option values at each step. 3 We can calculate the relative changes u,d in the binomial tree if we know the volatility and mean return of the stock. In this formulation, we are assuming the price movement as a logarithm process. To calculate the relative changes, we can use 1+U=et and 1+D=et In this process, we can calculate k(0,T)=ln(ST/S0) (Proposition 2.12 in the text). Price a 5 month call option where the =0.20,S0=62, expiration is 5 months, the strike, X, is 60 , and the annual rate of interest is 10% compounded monthly. - What is the risk-neutral probability? - Draw the entire tree showing all stock prices and option values at each step