A certain stock has a price of $110.00 now. Tomorrow, it will be worth eitherexa

Question

A certain stock has a price of $110.00 now. Tomorrow, it will be worth eitherexactly $ 150.00, or exactly $ 50.  (Assume   r = 0.)

                           150

            110

                            50

a. What are the“risk-neutral probabilities” associated with the twobranches?

b. A certainput option on this stock has a strike price of K = $90. What will that option be worth tomorrow if the stockprice goes up ?

c. What is theoption worth tomorrow if the stock price goes down ?

d.   Whatshould the price of the option be today ?

e.   Designa combination of   x   shares of stockand   y dollars cash that guarantees the sameresults (tomorrow) as the option.

Explanation / Answer

(a ) p(150) + (1-p)(50) = 110.      p =3/5, 1-p=2/5

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