Answer:
Based on the binomial model, the option's value is $3.00
Explanation:
The stock range of payoffs in one year is $27 - $17 = $10.
At expiration, if the stock price is $27, the option will be worth
= $27 - $22
= $5
And the option will be worth zero, if the stock price $17.
The range of payoffs for the stock option is $5 & $0 ; 0 = $5.
Equalize the range to find the number of shares of stock:
Option range/Stock range = $5/$10
= 0.5
With 0.5 shares, the stock options payoff will be either $13.5 or $8.5. The portfolio & options payoff will be
$13.5 - $5 = $8.5, or $8.5 $0; 0 = $8.5.
The present value of $8.5 at the daily compounded risk-free rate is: PV = $8.5 / (1+ (0.06/365))365 = $8.005.
The option price is the current value of the stock in the portfolio
minus the PV of the payoff: V = 0.5($22) - $8.005 = $3.00.
Therefore, Based on the binomial model, the option's value is $3.00
