Probability of low price = Probability of price decrease during period 1
× Probability of price decrease during period 2
= (1 – p
2
) × (1 – p
1
)
= (1 – 0.4077) × (1 – 0.4077)
= 0.3508
Since the call option is in-the-money only at the high price, the call price is calculated with the probability
of 0.1662 in the two-period model, whereas it is calculated with the probability of 0.4082 in the single-
period model.
is is the major advantage of a binomial model, as the call price movement is based on what happens
to the stock price in the interim period before expiry. In a single-period model, we do not give im ...
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