**Trading Case
OP1 **

**Case Objective**

To understand the one-period binomial option pricing
model.

**Key Concepts**

Binomial option pricing
model; option replication.

**Case
description**

In OP1 four markets are open: stock, bond, put and call option
markets. The markets cover one month of
calendar time, but you trade only the first day. That is, at the close of the first trading
day time will flash by and your position is marked to the realized end of month
payoffs. You can trade the stock at 20
during the trading day. By the end of the month the stock is equally
likely to go up to 40 or down to 10 which in turn determines the realized end
of month option values. The interest
rate for borrowing and lending is 1% for the month. Any positive cash balance you have at the end
of the first trading day earns 1% interest and any negative balance pays
1%. Both options expire at the end of
the month, and have a strike price of 25.
There is price discovery in each market except the stock, which you can
buy or sell at 20 during the trading period.

**Case Data**

The following one-period binomial tree shows the
cash flows from each security at the end of the month depending on whether the
stock goes up or down which is equally likely:

In the trading period securities are exchanged using market cash. Your end of period final market cash balance determines your earning grade cash as follows:

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