Based on the spot price of $26 and the strike price $28 as well as the fact that the risk-free interest rate is 6% per annum with continuous compounding, 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%.
- Use a two-step binomial tree to calculate the value of an eight-month European call option using the no-arbitrage approach.
- Use a two-step binomial tree to calculate the value of an eight-month European put option using the no-arbitrage approach.
- Show whether the put-call-parity holds for the European call and the European put prices you calculated in a. and b.
- Use a two-step binomial tree to calculate the value of an eight-month European call option using risk-neutral valuation.
- Use a two-step binomial tree to calculate the value of an eight-month European put option using risk-neutral valuation.
- Verify whether the no-arbitrage approach and the risk-neutral valuation lead to the same results.
- Use a two-step binomial tree to calculate the value of an eight-month American put option.
- Calculate the deltas of the European put and the European call at the different nodes of the binomial tree.
When using no-arbitrage arguments, you need to show in detail how to set up the riskless portfolios at the different nodes of the binomial tree.