a two (2) period european call Stock price= $50 Strick price=$45 Up move size= 1.25 rfr= 7 compute call option value today A= 12.51 B= 10.2 C= 9
A
A first do the 2 period stock pricing up move is 1.25 - down move is 1/1.25 = .80 ------------------ 78.13 (- 45.00 = 33.13) ------ 62.50 50.00 ------------50.00 (-45.00 = 5.00) ------- 40.00 -----------------32.00 (-45.00 is negative, so 0) Then, calculate the chance of upmove/downmove up = 1+r-D/U-D = .6 down=1-up = .4 Then you just take (.6* 33.13) + (.4*5)/1.07 = 20.45 (.6 * 5.00) + 0/1.07 = 2.80 Then discount these numbers one more time (.6 * 20.45)+(.4 * 2.80)/1.07 = 12.51