Chris Minwegen, Ben Campbell, Cooper Sampson

1.
You want to price the following options on MSFT stock. Its current price is $337 per
share. The options all expire in 6 months. The 6 month risk-free bond earns a 3%,
compounded continuously. You believe that MSFT stock price can go one of two
directions in the next 6 months: up 12% (with probability of 65%) and down 4% (with
probability of 35%).
Use risk-neutral probabilities to price the following options:

1e^(.03*.5) = 1.015

E^rt = 1.015
U = 1.12
D = 0.96

(1.015- .96) / (1.12 - .96) = .344 = pi

1 -.344 = .656

337 either goes to $377.44 or $323.52

Put option with K = 350

350-323.52 = 26.48

.344(0) + .656(26.48) = $17.37

8.84/1.015 = $17.11
Call option with K = 335

377.44-335= 42.44

.344(42.44) + .656(0) = $14.60

13.91/1.015 = $14.38

Put option with K = 325

325-323.52 = 1.48

.344(0) + .656(1.48) = .97

.97/1.015 = $0.96

Call option with K = 365

377.44-365= 12.44

.344(12.44) + .656(0) = $4.28

4.28/1.015 = $4.22

2.
You are looking at two-period binomial modeling for options on ABC stock that expire in
exactly 1 year. You believe that the probability of an up movement in each of the next 6-
month periods is 75% with an up factor of 1.20, and the probability of a down movement
is 25% with a down factor of 0.92. The current stock price is $35 per share. The risk-
free rate is 1%, compounded continuously.
What is the price of a European call option on ABC stock with a strike price of $37 that
expires in one year?
S = $35
U = 1.20
D = .92

In first 6 months:

Current Price of $35 goes up to $42 (75% chance)

and down to $32.2 (25% chance)

In the following 6 months:

$42 goes up to $50.40 and down to $38.64

$32.20 goes up to $38.64 and down to $29.62

Risk free return for the first period = 1.01

1e^(.01 * .5) = 1.005

Risk free return for the second period = 1.010

1.005^(.01*.5) = 1.01

K = 37

uu= $50.40 - 37 = $13.40

ud= $38.64 - 37 = $1.64
dd= $29.62 - 37 = $0

Cuu = 13.40
Cud = 1.64
Cdd= 0

Now we need to solve the outer nodes first.

Cu:
Up (75%) → $13.40
Down (25%) → $1.64

50.40 deltac + 1.01Bc = 13.40

38.64 deltac + 1.01Bc = 1.64

11.76 delta c = 11.76

Delta of the call = 1
Bc = -36.63

Cu = (1 * 42) - 36.63 = 5.37

Cd:

Up = 1.64
Down = 0

38.64 delta + 1.01bc = 1.64

29.62 delta + 1.01bc = 0

8.92 delta =1.64

Delta = .184
Bc = -5.42

Cd = (.184 * 32.20) - 5.42 = 0.505

Now:

C goes up to 5.37
C goes down to .505

What is C?

42 delta c +1.01bc = 5.37

32.20 delta c +1.01bc = .505

9.8 delta c = 4.865

Delta of the call = 0.496
Bc = -15.31
C = (35 * .496) - 15.31 = $2.05