A futures price is currently 40 cents.It is expected to move up to 44 cents or down to 34 cents in the next six months.The risk-free interest rate is 6%.What is the value of a six-month put option with a strike price of 37 cents?
A) 3.00 cents
B) 2.91 cents
C) 1.16 cents
D) 1.20 cents

Question

Quizplus · Accepted Answer

The probability of an up movement is (1-d)/(u-d).In this case u is 1.1 and d is 0.85.The probability of an up movement is therefore 0.15/0.25=0.6.The option pays off zero if there is an up movement and 3 cents if there is a down movement.The value of the option is therefore 0.4×3×e^-0.06×0.5= 1.16 cents.

A Futures Price Is Currently 40 Cents