Question: A binomial tree with three-month time steps is used to value a stock option. The domestic risk-free rate is 5% and the stock does not pay a dividend. The standard deviation of the annual rate of return on the stock is 20%.
a) What is the risk neutral probability of an up movement?
b) Using the binomial model, derive the value of a 9-month European call option with a strike price of $103 given that the stock price today is $100.