Binomial pricing: You are fortunate enough to own a put option with a strike price of $50 on the stock of ABC, Inc. The current stock price is $4. When the option expires, you expect the stock price to be either $2 or $5. The risk-free rate of interest is zero. What is the value of your option?

Question

Quizplus · Accepted Answer

Using binomial option pricing, we can calculate the expected value of the option at expiration:

Value if stock price is $2: $50-$2=$48 (in-the-money)
Value if stock price is $5: $50-$5=$45 (out-of-the-money)

Probability of stock price being $2: 0.5
Probability of stock price being $5: 0.5

Expected value = (0.5 x $48) + (0.5 x $45) = $46

Therefore, the value of the put option is $46.

Binomial Pricing: You Are Fortunate Enough to Own a Put