A Stock Is Currently Trading at $50 $\mathcal { U } = 1.2$

question 10

Multiple Choice

A stock is currently trading at $50. In each month, the stock will either increase in price by a factor of $\mathcal { U } = 1.2$ or fall by a factor of $d = 0.9$ . The risk-free rate of interest is 0.0834% per month in simple terms, i.e., an investment of $1 today returns $1.00834 after one period. Consider a 52-strike, three-month European put option when a dividend of $0.5 is paid at the end of each month. Assume that the company just announces a cancellation of future dividends. Ceteris paribus, by how much does the option price change on this announcement? (Assume that if the option is exercised, it is done before dividends are paid.)

• A) The option price drops by $0.39
• B) The option price drops by $0.69
• C) The option price rises by $0.39
• D) The option price rises by $0.69

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Definitions:

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