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Suppose that a share price S is currently $100, and that tomorrow it will be either $101, with probability p, or $99, with probability 1
Suppose that a share price S is currently $100, and that tomorrow it will be either $101, with probability p, or $99, with probability 1 - p. A call option, with value 0, has exercise price $100 Set up a Black- Scholes hedged portfolio and hence find the value of C. (Ignore interest rates.) Now repeat the calculation for a cash-or-nothing call option with payoff $100 if the final asset price is above $100, zero otherwise. What difference do you notice? This very simple discrete model is the basis of the binomial method, described in Chapter 10
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