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What is the early exercise premium

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Question - A stock price is currently $80. Over each of the next two six-month periods, it is expected to go up by 6% or down by 6%. The risk-free interest rate is 5% per year with semi-annual compounding.

Part I - Use the two-steps binomial tree model to calculate the value of a one-year American put option with an exercise price of $80.

Part II - Is there any early exercise premium contained in price of the above American put option? If there is, what is the early exercise premium?

Part III - Discuss how you can hedge risk if you write the above put option with an exercise price of $80 and 1-year maturity.

Reference no: EM133010500

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