This is actually an exercise from a course. But I don't completely understand the wording of the question.
- A stock is now trading at 100 dollars.
- Its price over the next 6 months evolves as a two step binomial process.
- Over each 3 month period, the price can go up by a factor $u$, or down $d=\frac{1}{u}$.
- The annual risk free rate is 5% (cont.).
- We consider an European put with strike price $K=93$ dollars and expiring in 6 months.
Part a) and b) are about pricing the put using risk-neutral pricing approach.
But part c) states:
Now suppose that in 3 months, the stock pays a dividend of 10 dollars. On the payment date, the stock price immediately adjusts to its ex-dividend level and then either goes up by a factor $u=1.1$ or down $d=1/u$ over the subsequent 3 months. Construct a dynamic self-financing strategy that replicates the payoff of the put.
Alright, so my question is. I don't know what happens when people know the stock is going to pay out 10 dollars of dividend in 3 months.
Is it during the next period, there are 2 states:(100*1.1-10=100, 100/1.1-10=80.90)????