Question 1
Consider a one year put option on JWK Corp shares. The current stock price is $80, the strike price is $85, the risk free rate is 3% per annum, the stock price volatility is 25% per annum, the stock is not expected to pay any dividends over the next year and the underlying of each option is one JWK Corp share.
Assume the option is European and the stock price follows twelve-period multiplicative binomial prices over the next year. Use risk neutral valuation to determine the current value of the option.
If we instead assume that the stock price follows six-period multiplicative binomial prices over the next year, what is the current value of the option? Without calculation, comment on whether the option price computed using the Black-Scholes model should be higher or lower than the option price computed using the 12-period Binomial model and explain your answer.
Question 2
Reconsider the option in question 1 but instead assume it is American.
Use a twelve–period binomial replication model to determine the current value of the option. Compare your answer to that in question one and briefly comment.
Please use calculation if needed and text-in reference with APA.
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