What is a lower bound for the price of a three-month European put option on a non-dividend-paying stock when the stock price is $12, the strike price is $21, and the risk-free interest rate is 7% per annum?

Finance Dec 21, 2020

Expert Solution

Given,

Stock price = $12

Strike price = $21

Risk free rate = 7% = 0.07

time period in years = 3/12 = 0.25

A European put option is the right to sell the option at a predetermined price on a specific day.

The lower bound is given by the formula,

lower bound = (strike price*e^(-rt)) - stock price

= (21*(e^(-0.07*0.25))) - 12

= 21*e(-0.0175) - 12

= 21*0.9826 - 12

= 20.6346 - 12

= 8.6346

Therefore the lower bound on a 3 month European put option is 8.63

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