Put Option.

Shares in OMEGA are currently trading at $10. The company is about to pay a dividend of $2 a share and the share price will then decline to $8. Over the subsequent quarter, the share price will either rise by 35% or decline by 25%. Note that the share price will go up or down only once over the coming quarter. The continuously compounded risk-free rate is 8% per annum. Consider a three-month European put option on a share of OMEGA with an

exercise price of $10.50.

• (a) What are the two possible values of an OMEGA share at the end of the quarter?
• (b) What positions in OMEGA stock and bonds will replicate the payoff to this put and what is the cost of the replicating portfolio?
• (c) Check your valuation using the risk-neutral pricing technique.
• (d) What would be the price of the put if it were an American-style option?