You are required to price a call option on XYZ.com with an exercise price of $60 and six months to expiration. The current stock price of XYZ.com is $60, the risk free rate is 8% p.a. (c.c.) and the volatility of the stock price of XYZ.com is 30% p.a.. XYZ.com will pay a dividend of $1 in exactly four months’ time. This call option is to be priced using a two-period binomial option pricing model, with three months in each period.
Required:
• Draw the two-period tree diagram for the adjusted stock price (that recognizes the impact of the dividend) of XYZ.com. Show the expiration date payoffs from the call option.
• Compare an American call option with an otherwise identical European call option on the stock of XYZ.com. What is the value of the right to exercise the call option before expiry.