FIN4110

Options and Futures

S2-2023

Topic 7
The Black-Scholes-Merton Model

Haifeng Wu
Expected Learning Outcomes

1. Markov process
2. Wiener process
3. Generalized Wiener process
4. Ito process
5. Ito’s Lemma and its applications
6. Construction of Black-Scholes risk-free portfolio
7. The Black-Scholes-Merton model
8. Explaining the Black-Scholes-Merton differential equation
9. Black-Scholes-Merton model on a dividend paying stock
Markov processes
◼ In a Markov process, future movements in a variable
depend only on where they are now, not on the history
of how they got there.
◼ We assume that stock prices follow a Markov Process.
This is consistent with a weak form of market
efficiency.
◼ Mathematically, this means that for any “reasonable”
function, f, the conditional expectation satisfies:
E[f(St)|all past prices] = E[f(St)|today’s price only]

◼ This implies that the changes in value at different time

intervals are independent.
Markov process – stock returns and variances
◼ Therefore, a stock’s return on day t+1, Rt+1, is
independent of the stock’s return on day t, Rt.

◼ If they’re independent, then they are uncorrelated. So,

variances of stock return over a period of time are
additive:

Var(R t + R t +1 ) = Var(R t ) + Var(R t +1 )

Markov process – stock returns

◼ If we use continuously compounded returns, then

 St 
Rt = ln   = ln St − ln St -1
 St -1 
 St +1 
Rt +1 = ln   = ln St +1 − ln St
 St 

◼ So that the two-period return is

Rt + Rt +1 = ln St +1 − ln St − (ln St − ln St -1 )
= ln St +1 − ln St -1 = ln (St +1 / St -1 )
Markov process – variances
◼ In general, the T-period return is
ln (ST / S0 ) = R1 + R2 + ... + RT
◼ taking variances (and assuming independence)

Var(R T − periods ) = Var(R1 ) + Var(R 2 ) + ... + Var(R T )

◼ if we assume that variances are equal from period to
period
Var(R1 ) = Var(R 2 ) = ... = Var(R T )
 Var(R T − periods ) = T  Var(R1 )
Markov process – variances

◼ If we know the variance of daily returns and if we

assume that there are 252 trading days in a year,
then

◼ Var(annual returns) = 252×Var(daily returns),

◼ And standard deviations are (taking square roots):

St.Dev(annual returns) = 252×St.Dev(daily returns)

◼ This means that variances are additive, while

standard deviations are not additive.
Weak-form market efficiency

◼ This asserts that it is impossible to produce

consistently superior returns with a trading rule
based on the past history of stock prices. In other
words technical analysis does not work.

◼ A Markov process for stock prices is clearly

consistent with weak-form market efficiency.
Question:

◼ A stock price is currently at $40. The change in

its value during one year is N(0,10) where N(µ,σ)
is a normal distribution with mean µ and standard
deviation σ.

◼ What is the probability distribution for the change

in the value of the stock price during 2 years, ½
years, ¼ years, and any time interval?
Wiener process (brownian motion)
◼ We consider a variable Z whose value changes
continuously over time. For a small change in time,
∆t, we’ll call the change as the random (stochastic)
process, ∆Z.

◼ The process {Z} follows a Wiener process if

1. Z =  t , where ε follows a standard normal
distribution, and εt and εt + 1 are independent.
2. The values of ∆Z for any two non-overlapping
periods of time are independent.
3. Z has continuous paths.
Plot of wiener process

Z = t
where  ~ N (0,1)

Z0 = 0

0 t
Properties of wiener process

◼ For each t, Z is normally distributed.

◼ The mean of [ZT − Z0] is E[ZT − Z0] = 0.
◼ The variance of [ZT − Z0] is Var[ZT − Z0] = T
◼ The standard deviation of [ZT − Z0] is T

◼ NOTE: it is usually assumed that Z0 = 0.

◼ Taking the limit as ∆t approaches zero, we replace

Z =  t by dZ =  dt
Generalized wiener processes

◼ A Wiener process has a drift rate of 0 and a

variance rate of 1.

◼ Note that the mean change per unit time for a

stochastic process is known as the drift rate and the
variance per unit time is known as the variance rate.

◼ In a generalized Wiener process the drift rate and

the variance rate can be set equal to any chosen
constants.
More specifically:
◼ A variable X follows a generalized Wiener process with
drift rate a and variance rate b2 (with a and b constant)
if
dX = adt + bdZ
◼ or
x = a t + b  t
➢ Mean change in X over t is at
➢ Variance of change in X over t is b2 t
➢ Standard deviation of change in X over t is b t
Drift and variance rates
◼ X is just a simple function of the Brownian motion, Z.
2
◼ How do we interpret the drift rate, a, and the variance rate, b ?
◼ We can see that the mean change in X in the time interval T is

EXT − X0  = EaT + bZT  = aT

◼ The variance of change in X in the time interval T is

Var X T − X 0  = Var aT + bZT  = b 2 T

◼ The standard deviation of change in X in time interval T is

St.DevX T − X 0  = b T

◼ Note that initial time t is assumed to be zero.

Distribution of XT

◼ It follows that XT is normally distributed with mean

X0 + aT, and standard deviation b T

◼ We sometimes write that XT has the probability

distribution N(X0 + aT, b T ) which is written as

XT ~ N(X0 + aT, b T)
 Example 1

◼ Suppose a stock price starts at $40 and the price

follows a generalized Wiener process with no drift
and standard deviation 10 (i.e., $10 per year):

dS = 10dZ.

◼ Then the stock price in one year is normally

distributed with a probability distribution N(40,10).
Example 2

◼ If the stock price is expected to grow by $8 on

average during the year, then the process is

dS = 8dt + 10dZ

◼ and the stock price in one year is normally distributed

with a probability distribution N(48,10).

◼ Question: What is the distribution of the stock price in

one month?
Generalized wiener process: is this a reasonable
process to describe dynamics of stock prices?
◼ There are two principal reasons of why a generalized
wiener process is NOT appropriate.
◼ A generalized Wiener process is normally distributed,
=> it can become negative. But stock prices can’t be
negative. A more reasonable model would assume that
continuously compounded returns are normally
distributed
ln(ST / S0 ) = aT + bZ T
◼ If stock prices follow a generalized Wiener process, then
the variance of stock’s prices is constant, regardless of
price level. It’s more reasonable to assume that returns
have a constant variance, regardless of price level.
Itô process

◼ In an Itôprocess the drift rate and the variance

rate are functions of time and underlying
variable:
dx=a(x,t) dt+b(x,t) dz

◼ The discrete time equivalent

x = a ( x, t )t + b( x, t ) t
is only true in the limit as t tends to zero
An Itô process for stock prices

dS = mS dt + sS dz
◼ where m is the expected return and s is the
volatility.

◼ The discrete time equivalent is

S = mSt + sS t
Monte-carlo simulation

◼ We can sample random paths for the stock

price by sampling values for 

◼ Suppose m= 0.14, s= 0.20, and t = 0.01,

then

S = 0.14 S t + 0.2 S  (t )^ (0.5)

Monte-carlo simulation of stock prices

Stock Price at Random Change in Stock

Period Start of Period Sample for  Price, S

0 20.000 0.52 0.236

1 20.236 1.44 0.611
2 20.847 -0.86 -0.329
3 20.518 1.46 0.628
4 21.146 -0.69 -0.262
Review of ordinary calculus I
◼ Before presenting Ito’s lemma, we need to review some
results from ordinary calculus.
◼ Derivatives of some common functions:

d x
e =  e x
dx
d n
x = nxn−1
dx
d 1
ln(x) =
dx x
Review of ordinary calculus II

◼ The second derivative is just the derivative of the first

derivative.

d2 d d 
f(x) =  f(x)
dx 2
dx  dx 
◼ Example

d 1  d
 
2
d 1
ln(x) =  = x = −x = − 2
-1 -2

dx 2
dx  x  dx x
Review of ordinary calculus III
◼ Differentiation with two or more variables:
◼ Consider a function of two variables, say G(x,t).
If we want to find the partial derivative of G with respect
to x, we can treat the other variable as a constant.
◼ Example with

G(x, t) = xet
  t
G ( x, t ) = xe = et
x x
  t
G ( x, t ) = xe = x(et ) = xet
t t
Review of ordinary calculus IV
◼ the (total) differential of G(x,t) is given by

G G
dG = dx + dt
x t

◼ In the case where G is independent of time, and is only a

function of x: G = G(x). Then integrating the differential
dG from a to b, say, is
b dG b
G (b) − G ( a ) = a dx
dx = 
a
G( x) dx

which called the Fundamental Theorem of Calculus.

Itô’s Lemma

◼ If x follows an Ito process, dx=a(x,t) dt+b(x,t) dz, then a

function of x and t, G (x, t ), also follows an Ito process,
specifically,

 G G 1  G 2  G
2
dG =  a+ + b dt + bdz
 x t 2 x x
2

Applications: process of a derivative price

◼ Assume that stock price S follows an Ito process:

dS=µSdt + σSdZ. We want to know the process of a
derivatives price, where
1 3
F= S
3
◼ We apply Ito lemma: if S follows an Ito process, F
also follows an Ito process and is given by

(i) a = mS (ii ) b = sS
F F  2
F
(iii) = 0 (iv) = S (v)
2
= 2S
t S S 2
Applications: process of a derivative price
 F F 1  2 F 2 2  F
dF =  mS + + s S  dt + sSdZ
 S t 2 S S
2

 2 1 2 2 
=  S mS + s S 2 S  dt + S2sSdZ
 2 
( )
= m + s S dt + sS dZ; since F = S
2 3 3 1 3
3
= 3( m + s ) Fdt + 3sFdZ
2

◼Hence, if the stock price process is dS = µSdt + σSdZ,

then the derivative price process is dF = 3(µ+σ2)Fdt+3σFdZ
Process of stock prices (St)

One type of Ito process takes the form:

dS = mS dt + sS dz
◼ dS is the change in S over a small time interval dt
◼ m is the expected rate of return per unit time for S
◼ s is the volatility of S.
◼ We call this process Geometric Brownian motion
◼ Is this process a reasonable model of how stock
prices evolves? (how about jumps?)
Process of ln(St)

◼ If S follows: dS = mS dt + sS dz
◼ Let G = Ln(St). Then G also follows an Ito process:
G G 1  G 2 2 2
G
dG = ( mS + + s S )dt + sSdz
S t 2 S 2
S
◼and we know:

G 1 G 2
1 G
= =− 2 =0
S S S 2
S t
◼given we have a=μS and b=σS
Properties of ln（St）

◼So: dG = d {ln(St)} = (m - s2/2) dt + s dz

◼ G is a Generalized Wiener process

1 2
◼ G (ln（St）) has a drift rate (“a”) of:m − s
2

◼ and a variance (“b2”) of: s 2T

G=ln(St) is normally distributed

◼ Integrate dG, dG = (m - s2/2) dt + s dz, from 0 to t (m, s are

constants)
 s2
G (St ) − G (S 0 ) =  m − t + s (Z t − Z 0 )
 2 

ln (St ) − ln (S 0 ) =  m −
s2
(
t + s  t −  0 )
 2 

ln
(St ) 
=  m −
s2 
( )
t + s  t
(S0 )  2 

◼ Note:  is a normally distributed random variable N(0,1)

 ST   s2 
ln   ~ N  m − T , s T 
 S0   2  
Mean and variance of log returns

◼ The mean and standard deviation of log returns

over the period [0, T] are:

 ST   s2 
Mean of ln   =  m −  T
 S0   2 
 ST 
Stdev of ln   = s T
 S0 

◼ We can also write

 ST 
(
ln   ~  ( m − 12 s 2 )T , s T )
 S0 
St is lognormally distributed

◼ If we use the following Geometric Brownian Motion

process to model stock price S:
dS = mS dt + sS dz
◼ then continuously compounded returns are normally
distributed.
◼ and St is lognormally distributed with

2 2 m (T −t ) s 2 (T − t )
E ( ST ) = S 0 e m (T −t )
and var(ST ) = S e
0 [e − 1]

◼ Lower bound of St is 0
◼ Stock prices cannot be negative
Pricing derivatives

◼ The price of a derivative is a function of:

1. the price of the underlying asset (which follows a
stochastic process)
2. Time

◼ Use Ito Lemma to characterize the behavior of a

function of a stochastic variable, e.g., the derivative’s
process is described using the process followed by the
underlying stock
Parameters

◼ m : the expected continuously compounded return

earned by the stock per year

◼ The value of a derivative dependent on a stock is

generally independent of the return

◼ s : the stock price volatility

➢ Critically important to value most derivatives
➢ Volatility can be interpreted as the standard deviation
of the change in the stock price in one year
The Black-Scholes-Merton differential equation

◼ Assumptions:

➢ The stock price follows a geometric Brownian motion.

➢ The short selling of securities is permitted.
➢ There are no transactions costs or taxes.
➢ All securities are perfectly divisible.
➢ There are no dividends during the life of the option.
➢ There are no arbitrage opportunities.
➢ Security trading is continuous.
➢ The risk-free rate of interest is constant and the same
for all maturities.
Step 1: form a risk-free portfolio
◼ The Black-Scholes analysis is similar to the no-
arbitrage analysis in valuing options when stock price
changes are binomial.

◼ Step 1: construct a riskless portfolio which consists

of a position in the option and a position in the
underlying stock.
➢ Under the assumption that stock price follows a
geometric Brownian motion, i.e.,

dS = mS dt + sS dz
Step 1: form a risk-free portfolio
◼ Based on Ito’s lemma, the price of a call option, f,
contingent on S (which is a function of S and t) follows a
process of
f f 1  2 f 2 2 f
df = ( mS + + s S )dt + sSdz
S t 2 S 2
S
◼ Comparing dS with df, note that they have the same
underlying uncertainty, dZ. This means that we can
construct a portfolio by writing one call option and buying
 f / S shares to eliminate this uncertainty (Wiener
processes cancel each other out) for a short period of
time. So the value of portfolio over the short time interval
does not follow a stochastic process.
Step 2: calculate value of the portfolio
◼ Define  as the value of the portfolio.
◼ By definition,
 = - f + (f /S)*S
◼ So, the change in the value of the portfolio, Δ, in the
time interval Δt is given by
Δ = - Δ f + (f /S)* ΔS
◼ Substituting the discrete versions of equations into the
above equation yields
Δ = (-f /t - 1/2 [2f /S2] s2S2 )Δt
◼ Since Δ does not involve Δz, the portfolio is riskless
during the time interval Δt.
Step 3: obtain Black-Scholes-Merton
differential equation
◼ In the absence of arbitrage opportunities, the return from
the portfolio should be the risk-free interest rate, i.e.,
 = rt
◼ Simplify this equation and obtain:

f f 1 2 2  2 f
+ rS + s S = rf
t S 2 S 2

◼ This is the Black-Scholes-Merton differential equation.

This equation must be satisfied by the price of any
derivative dependent on a non-dividend paying stock.
Solve for derivative price with boundary
conditions
◼ The derivative obtained when the equation is solved with
the boundary conditions :

➢ for a European call option, the condition is

f = Max(St-X , 0) when t = T.

➢ for a European put option, the condition is

f = Max(X-St ,0) when t = T.

◼ The closed form solution is the price of option, i.e., Black-

Scholes formula.
An alternative approach: risk-neutral
valuation
◼ Notice: m does not appear in the B-S-M differential
equation. That is, all variables pertaining to risk
preference are canceled out of the equation.

◼ Therefore, the solution to the equation, the price of the

derivative, is the same regardless of the riskiness of the
underlying.

f f 1 2 2  f 2
+ rS + s S = rf
t S 2 S 2
Risk-neutral valuation

◼ Since risk preference is not important, we can assume

that investors are risk neutral
◼ If investors are risk neutral, i.e. demand no premium
for risk, then μ=r
◼ Hence,

dS = rSdt + sSdZ
◼ Find the expected payoff
◼ Discount at r
Risk-neutral valuation of European options
◼ For European call & put options on non-dividend-paying
stocks:

c = e − r (T −t ) Eˆ maxST − X ,0 p = e E maxX − ST ,0

− r (T −t ) ˆ

◼ The solutions are:

c = SN (d1 ) − Xe− r (T −t ) N (d 2 )
p = − SN ( − d1 ) + Xe − r ( T − t ) N ( − d 2 )
◼ where:
ln( S / X ) + (r + s 2 / 2)(T − t )
d1 = ,
s T −t
ln( S / X ) + (r − s 2 / 2)(T − t )
d2 = = d1 − s T − t
s T −t
Risk-neutral probability of exercising a call options
◼ Risk-neutral probability that:
➢ ST>X, then ln(ST)>ln(X) and dS = rSdt + sSdZ
➢ It shows:
 ST  s2 s2
ln   ~ [(r − )(T − t ), s T − t ], so ln( ST ) ~ [ln( St ) + (r − )(T − t ), s T − t ]
 St  2 2
P ( ST  X )
ln( ST ) − mean ln( X ) − mean
= P(ln( ST )  ln( X )) = p (  )
stdev stdev
s2
ln( X ) − ln( St ) − (r − )(T − t )
= P(   2 )
s T −t
s2 s2
ln( X ) − ln( St ) − (r − )(T − t ) ln( St ) − ln( X ) + (r − )(T − t )
= P( Z  − 2 ) = P( Z  2 )
s T −t s T −t
s2 s2
ln( St / X ) + (r − )(T − t ) ln( St / X ) + (r − )(T − t )
= P( Z  2 ), given d 2 = 2
s T −t s T −t
= N (d 2 )
Risk-neutral probability of exercising a call options

◼ P(standard normal random variable < d2)= N (d 2 )

◼ 1-N(d2) = is the risk neutral probability that a put option

(ST<X on the same underlying with the same X and T)
will be exercised.
What about the volatility parameter?
◼ All inputs except the volatility are observable.
◼ In theory, the BS model has no room for dynamic/stochastic
volatility; it is assumed to be constant and thus identical under
both measures
◼ In practice, the BS volatility should be set to today’s expectation
of the underlying’s volatility over the life time of the option (under
the risk-neutral measure)
➢ This requires a more complex model of stochastic volatility
◼ Because high-vol states are considered bad states, BS-implied
variance should be higher than realized variance alone for that
reason
➢ There are several additional reasons that make the BS-implied
volatilities different from realized and even different by strike of the
option. We’ll discuss these later.
What about the volatility parameter?

◼ Holding all other parameters constant, there is a 1-to-1

mapping between option price and option volatility
➢ Given a price, we can back out the volatility. That’s why
we call it implied volatility (IV)

◼ Option traders use IV as a means to communicate

prices.
Implied volatility
◼ It is the volatility implied by an option price observed in the
market.
◼ For example, suppose that the value of a European call on a
non-dividend-paying stock is 1.875 when S=$21, X=$20, r=0.1
and T- t = 0.25. Based on the Black-Scholes model, we can
find the value of s (implied volatility) using an iterative search
procedure.
◼ There is no closed form equation to solve the implied
volatility directly, however we can obtained it by
approximation.
◼ Use more actively traded options to find s
◼ Implied volatilities are used to monitor the market’s opinion
about the volatility of a particular stock.
◼ Implied volatilities are forward-looking whereas historical
volatilities are backward looking.
◼ VIX index
Problems with Black-Scholes-Merton Model

◼ Pricing bias:
➢ Stock price does not follow a Geometric Brownian
Motion such as a “jump” stochastic process
➢ Interest rate is stochastic
➢ Volatility is stochastic
Black-Scholes pricing model for European
options on a dividend-paying stock
◼ If the amount and timing of the dividends during the life
of a European option can be predicted with certainty, the
Black-Scholes formula can be used provided that the
stock price is reduced by the present value of all the
dividends during the life of the option

− r (T −t )
c = S N (d1 ) − Xe
*
N (d 2 )
− r (T − t )
p = Xe N (−d 2 ) − S N (−d1 )
*
Black-Scholes pricing model for European
options on a dividend-paying stock

where
S * = S −  e − rt k Dk
k

ln( S * / X ) + (r + s 2 / 2)(T − t )
d1 =
s T −t

d 2 = d1 − s T − t
 Example
◼ Consider a European call option on a stock when
there are ex-dividend dates in two months and five
months. The dividend on each ex-dividend date is
expected to be $0.50. The current stock price is $40,
the strike price is $40, the stock price volatility is 30%
per annum, the risk-free rate of interest is 9% per
annum, and the time to maturity is six months. What
is the option price?
Solution

◼ PV(D) = 0.9741

◼ S* = 40-0.9741=39.0259

◼ d1= 0.2020, and N(d1)=0.5800 (using the table given in

the textbook)

◼ d2 = -0.0102, and N(d2)=0.4960 (using the table given

in the textbook)

◼ c = 3.67
Early exercise of American call options
◼ RECALL: An American call on a non-dividend paying
stock should never be exercised early.

◼ If an American call on a dividend-paying stock is

exercised early, it should only be exercised immediately
prior to an ex-dividend date (i.e., before the price drops
due to the dividend payment).

◼ Suppose the stock pays n dividends, D1,..., Dn at times t1,

…, tn, between now (time 0) and maturity (time T).
Early exercise of American call options

◼ Consider the possibility of exercising before the final

dividend: if the call is exercised just before time tn, the
holder receives the intrinsic value = S(tn) - K.

◼ If the call is not exercised, the stock price will be

expected to drop to S(tn) - Dn. We know that the call
price is bounded below: C(tn)> S(tn) - Dn - Ke-r(T-t(n)).

◼ If S(tn) - K < S(tn) - Dn - Ke-r(T-t(n)), the intrinsic value is

less than the call price. DO NOT EXERCISE the call;
keep it alive.
Early exercise of American call options
◼ Consider the dividend at tn-1: if call is exercised then holder
receives S(tn-1) – K; if call is not exercised stock price drops
to S(tn-1) – Dn-1.

◼ If S(tn-1) – K < S(tn-1) – Dn-1- Ke-r[t(n)-t(n-1)] not optimal to

exercise the option at tn-1.

◼ it may be optimal to exercise the option immediately prior to

an ex-dividend date ti if
− r ( t i +1 − t i )
Di  X (1 − e )
where Di is a dividend and ti is the time right before the
stock going ex-dividend.
Pricing for American call options
◼ For an American call option on non-dividend-paying
stock, the value is the same as the value of the
corresponding European call option.

◼ For an American call option on dividend-paying stock,

Black suggests an approximation procedure:
➢ calculate the prices of European call options that mature at
times T and ti (time you may consider to exercise the
options prior to maturity), respectively
➢ Approximate the American price as the greater of the two.

◼ Alternatively use Binomial model

Example
◼ Consider six-month American call option with S=40,
X=40, r=0.09, D1=D2=0.5, s=0.30, t1 occurs after two
months, and t2 occurs after five months. When might
the option be exercised ? What is the price of option?
− r ( t 2 − t1 )
X (1 − e ) = 0.89
− r ( T − t2 )
X (1 − e ) = 0.30

◼ Because 0.89 > 0.5 and 0.3 <0.5, the option might be
exercised right before the second ex-dividend date.
◼ A stock has an expected return of 16% and a volatility of 35%.
The current stock price is 68 and the risk-free rate is 10%
1. What is the real probability that the stock price will higher than
75 and in 6 months?
2. What is the risk-neutral probability that a European Call option
on the stock with exercise price of 75 and a maturity date in 6
months will be exercised?
3. What is the risk-neutral probability that a European Put option on
the stock with same exercise price and maturity will be
exercised?

◼ Show that the BSM model for call and put options satisfy put-call
parity.
◼ Calculate the price of a 3-month European put option an a non-dividend-
paying stock with a strike price of 50 when the current stock price is 50,
the risk-free rate is 10% per year, and the volatility is 30% per year?
What will be the price for the same put option if a dividend of 1.5 is
expected in 2 months?

◼ Consider an American call option on a stock, the stock price is 50, it has
15 months maturity time, risk-free rate is 8%, the exercise price is 55
and the volatility is 25%. Dividends of 1.5 are expected in 4 months, 10
months and 18 months. It this call option optimal to be exercised prior to
these three dividend dates and what is the price of the option?
◼ A variable, x, starts at -20 and follows a generalized Wiener process dx = adt
+ bdz During the first two years, a = 5 and b = 4. During the following three
years, a = 8 and b = 6. What is the mean value of the change of variable x
after five years?
a. 45
b. 65
c. 14
d. 34
e. none of the above

◼ What is the standard deviation of the variable x after five years?

a. 26
b. 5.09
c. 11.83
d. 140
e. none of the above
◼ The share price of company CBA exhibits an instantaneous drift of 17%
per year with a return volatility of 23%. What is the probability of the
CBA shares fall below $105 after 9 months when that cost $120 today?

◼ If a stock price S follows GBM, what will be a 95% confidence interval

for ST in time T? (GBM ~ dS=μS dt+σS dz)
◼ A stock has an expected return of 16% and a volatility of 35%. The
current stock price is 68 and the risk-free rate is 10%
1. What is the real probability that the stock price will higher than 75 and
in 6 months?
2. What is the risk-neutral probability that a European Call option on the
stock with exercise price of 75 and a maturity date in 6 months will be
exercised?
3. What is the risk-neutral probability that a European Put option on the
stock with same exercise price and maturity will be exercised?
Thank You