You are required to price a put option on XYZ.com with an exercise price of $60 and six months to expiration. The current stock price of XYZ.com is $62, the risk free rate is 12% p.a. (c.c.) and the volatility of the stock price of XYZ.com is 40% p.a.. XYZ.com will pay a dividend of $1 in exactly four months’ time. This put option is to be priced using a two-period binomial option pricing model, with three months in each period.
Required:
(a) 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 put option.
(b) Compare an American put option with an otherwise identical European put option on the stock of XYZ.com. What is the value of the right to exercise the put option before expiry?