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Q1. Discrete option pricing
Stock takes 6 scenarios at option expiration:
scenario outcome prob
1 1 0.05
2 2 0.15
3 3 0.30
4 4 0.30
5 5 0.15
6 6 0.05
Consider a call option with strike X=4. Assume rf=0
a. what is the probability that call with expire ITM?
b. what is the conditional probability for the two scenarios that call will be in the money (outcome 5 and 6)
c. what is the conditional value of the underlying stocks when call expires ITM?
d. what is the conditional call payoff when it expires ITM?
e. how much should the option be valued today?
for additional exercise: redo the question with a put option.
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