CHAPTER 21

If thestockpriceinmonth6is440thenthecallisworth

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Unformatted text preview: hould not exercise early. Finally, the value today of the American put option is: [(0.4 ´ 0) + (0.6 ´ 110)]/1.10 = \$60 c. Unlike the American put in part (b), the European put can not be exercised prior to expiration. We noted in part (b) that, If the stock price in month 6 is \$110, the American put would be exercised because its value if exercised (i.e., \$110) is greater than its value if not exercised (i.e., \$90). For the European put, however, the value at that point is \$90 because the European put can not be exercised early. Therefore, the value of the European put is: [(0.4 ´ 0) + (0.6 ´ 90)]/1.10 = \$49.09 7. The following tree shows stock prices, with option values in parentheses: With dividend Ex­dividend We calculate the option value as follows: 1. The option values in month 6, if the option is not exercised, are computed as follows: If the stock price in month 6 is \$110, then it would not pay to exercise the option. If the stock price in month 6 is \$440, then the call is worth: (440 ­ 165) = 275. Therefore, the option would be exercised at that time. 2. Working back to month 0, we find the option value as follows: b. If the option were Eur...
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