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In this question, you need to price options with binomial trees. You will consider puts and calls on a share with the spot price of

In this question, you need to price options with binomial trees. You will consider puts and calls on a share with the spot price of $30. The strike price is $34. Furthermore, assume that over each of the next two four-month periods, the share price is expected to go up by 11% or down by 10%. The risk-free interest rate is 6% per annum with continuous compounding.

  1. Use a two-step binomial tree to calculate the value of an eight-month European call option using the no-arbitrage approach.
  2. Use a two-step binomial tree to calculate the value of an eight-month European put option using the no-arbitrage approach.
  3. Show whether the put-call-parity holds for the European call and the European put prices you calculated in a. and b.
  4. Use a two step-binomial tree to calculate the value of an eight-month European call option using risk-neutral valuation.
  5. Use a two step-binomial tree to calculate the value of an eight-month European put option using risk-neutral valuation.
  6. Verify whether the no-arbitrage approach and the risk-neutral valuation lead to the same results.

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