The state price probabilities are the same as the

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Unformatted text preview: put price as This would be the price of an European put option. But an American put may be optimally exercised early, as we have seen earlier. The possible exercise point is at time 1 when the underlying is at . Exercising then has a value equal to , which is higher than the value of keeping the option “alive,” (value of the option if it is kept unexercised till the next period), equal to 5.78. To price the American option we therefore replace 5.78 with 10 in the calculation of the put price at time 0: ✯ ✟ ✟ ✟✟ ✟ ✟✟ ✟ ✯ ✟ ✟ ❍❍ ✟ ❍ ❍❍ ✟✟ ✟ ❍ ✟ ❍ ❥ ❍ ✟ ❍❍ ❍ ❍❍ ❍ ❍ ❥ ❍ 15.4 Adjusting for Dividends in the Binomial Model Options on a stock paying dividends is another case which is easily solved using the binomial model. Example We again use the underlying of the previous two examples, but we are now told that the company will pay dividend of $10 next period. If we assume the stock price falls by the amount of the dividend, we get a dividend adjusted binomial...
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