What is the risk-neutral probability

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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 = e^{σ √(δt)} and 1+ D = e^{-σ √(δt)}. In this process, we can calculate k(0, T) = ln(S_T/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.

Reference no: EM132184129

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