Kate is interested in buying a European call option written on EastJet Airlines Ltd., a non–dividend paying common stock, with a strike price of $75 and one year until expiration. Currently EastJet’s stock sells for $78 per share. In one year Kate knows that EastJet’s stock will be trading at either $93 per share or $65 per share. Kate can borrow and lend at the risk-free equivalent annual rate (EAR) of 2.5 percent.
a. What should the call option sell for today?
b. If no options currently trade on the stock, is there a way to create a synthetic call option with identical payoffs to the call option just described? If there is, how would you do it?
c. How much does the synthetic call option cost? Is this greater than, less than, or equal to what the actual call option costs? Does this make sense?

  • CreatedJune 17, 2015
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