Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Stock ZYX has current price S 0 = $100. Use a 2-step binomial tree for the price of this stock, with up-factor u = 0.1

Stock ZYX has current price S0 = $100. Use a 2-step binomial tree for the price of this stock, with up-factor u = 0.1 and down-factor d = −0.0909 per year in the next 2 years. The interest rate is zero.


(1) Use risk-neutral pricing to find the price of an European at-the-money call option with maturity T = 2 years based on the binomial tree.


(2) Assume that you sold this option. How would you hedge dynamically your position? Describe the strategy in detail, and show your stock and bond positions at each  node on the tree.


(3) A client calls you and wants to enter into an option which gives her the right (but not the obligation) to buy at time T = 1 for a strike price K = 5 the option described in point (1) above. As you see, this is an option on an option, and is also called a "compound option". What is the price of this compound option?

Step by Step Solution

3.45 Rating (164 Votes )

There are 3 Steps involved in it

Step: 1

1 Use riskneutral pricing to find the price of an European atthemoney call option with maturity T 2 years based on the binomial tree The riskneutral p... blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Income Tax Fundamentals 2013

Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill

31st Edition

1111972516, 978-1285586618, 1285586611, 978-1285613109, 978-1111972516

More Books

Students also viewed these Finance questions