In this question, you need to price options with various approaches. You will consider puts and calls on a share.
Based on this spot price (36) and this strike price (38) as well as the fact that the risk-free interest rate is 6% per annum with continuous compounding, please undertake option valuations and answer related questions according to following instructions:
Binomial trees:
Additionally, 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%.
Note: When you use no-arbitrage arguments, you need to show in detail how to set up the riskless portfolios at the different nodes of the binomial tree.
Black-Scholes-Merton model:
Using the information given above regarding the spot and strike price, risk-free rate of return and the fact that the volatility of the share price is 18%, answer following questions:
Note for calculations with the BSM model: Keep four decimal points for d1 and d2. Use the Table for N(x) with interpolation in calculating N(d1) and N(d2).
Finally,
Compare the results you obtained for the prices of European puts and calls using binomial trees and Black-Scholes-Merton model. How large are the differences when expressed as a percentage of the spot price of the share? Provide a possible explanation for these differences.
xls of the above available here: https://trtl.bz/2AruFiH
FOR PUT OPTION
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