The current price of XL Corporation stock is $40. In each of the next two years, this stock price can either go up by $15.00 or go down by $15.00.  XL stock pays no dividends.  The one-year risk-free interest rate is 15% and will remain constant. Using the binomial pricing model, calculate the price of a two-year American put option on LC stock with a strike price of $40.

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Asked Nov 5, 2019
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The current price of XL Corporation stock is $40. In each of the next two years, this stock price can either go up by $15.00 or go down by $15.00.  XL stock pays no dividends.  The one-year risk-free interest rate is 15% and will remain constant.

 

Using the binomial pricing model, calculate the price of a two-year American put option on LC stock with a strike price of $40.

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Expert Answer

Step 1

Calculate the probabilities:

p is 57.37% and 1-p is 42.63%.

 

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$55 ($40+S15) P $40 1-P $35 ($40-$15)

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Step 2
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(S55x (P))+ (s35x(1- P) = (S40 x (e3 0.15 $55P+$35-$35P = $46.473365 11.473365 P= 20 0.573668 or57.37% 1-P-[1-57.37% =42.63%

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Step 3

Create a binomial model:

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$70 ($40+S15+$15) $55 ($40+$15) Stock Price = $40 Strike Price = $40 $40 ($40+S15-$15) $35 ($40-$15) $20 ($35-$15)

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