Three step binomial tree approach prices of options

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Consider International Business Machine Corporation (IBM). The shares of IBM are currently trading at $87. Assume the yearly volatility of IBM is around 40%. Using a three step binomial tree approach prices of options with 6 months to maturity and strike price equal to $92. The annualized risk-free rate is equal to 5%. In two months the stock pays a dividend of $10. Compute the value of:

1. the European put option using the risk-neutral probability method

2. the European put option using the portfolio replication method

3. the American call option using the risk-neutral probability method

4. the American call option using the portfolio replication method

Reference no: EM131326938

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