Find an appropriate price for a european-style option

Reference no: EM13324141

Suppose that instead of our usual pricing scenario, we have a stock whose price will become either its square or its square root at the end of each period; that is, for k >=0,

Sk+1 = (Sk)^2 if Wk+1 = H

Sk+1 = sqrt(Sk) if wk+1 = T

where the initial price S0 of the stock is $4 per share. Find an appropriate price (at time 0) for a European-style option, expiring at time 2, whose payout is absolute value of (S2-4). Assume the risk-free interest rate r is 10%.

Reference no: EM13324141

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