In the previous problem, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today?
In the previous problem, You own a lot in Key West, Florida, that is currently unused. Similar lots have recently sold for $1.1 million. Over the past five years, the price of land in the area has increased 12 percent per year, with an annual standard deviation of 25 percent. A buyer has recently approached you and wants an option to buy the land in the next 12 months for $1.25 million. The risk-free rate of interest is 5 percent per year, compounded continuously. How much should you charge for the option?