We will derive a two-state put option value in this problem.

We have the following information:

S0 = 100 ; 1 + rf = 1.10

The two possibilities for STare 120 and 80.

a.Show that the range of S is 40 while that of put option is 30 across the two states. What is the hedge ratio of the put?

b.Form a portfolio of three shares of stock and four puts. What is the (nonrandom) pay-off to this portfolio? What is the present value of the portfolio?

c.Given that the stock currently is selling at 100, what is the price of this put option?