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Question - We can calculate the relative changes u , d in the binomial tree if we know the volatility and mean return of the stock. In this formulation, we are assuming the price movement as a logarithm process. To calculate the relative changes, we can use 1+U = eσ √(δt) and 1+ D = e-σ √(δt). In this process, we can calculate k(0, T) = ln(ST/S0) Price a 5 month call option where the σ = 0.20, S0 = 62, expiration is 5 months, the strike, X, is 60, and the annual rate of interest is 10% compounded monthly.
What is the risk-neutral probability?
Draw the entire tree showing all stock prices and option values at each step.
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