In recent years, many companies have started writing put options on their own stocks. This is...

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In recent years, many companies have started writing put options on their own stocks. This is also true in the case of the company ABC. The firm's total asset value equals $100,000. Moreover, its capital structure is composed of 2000 common shares outstanding and 1000 2-year European put options written by the company. At maturity, the holder of each put option has the right to sell a share of ABC to the company for $50 each. Assume, that before selling the share to ABC, the put option holders will be able to buy the ABC share in the open market at the current market price. Further, in the following two years, ABC's asset valuation will evolve according to a binomial tree. That is, the asset value will either increase or decrease by 20%. Finally, the risk-free interest rate (simple, annualized) is 10% and ABC will not pay any dividend. What is the current market value of one put option? In recent years, many companies have started writing put options on their own stocks. This is also true in the case of the company ABC. The firm's total asset value equals $100,000. Moreover, its capital structure is composed of 2000 common shares outstanding and 1000 2-year European put options written by the company. At maturity, the holder of each put option has the right to sell a share of ABC to the company for $50 each. Assume, that before selling the share to ABC, the put option holders will be able to buy the ABC share in the open market at the current market price. Further, in the following two years, ABC's asset valuation will evolve according to a binomial tree. That is, the asset value will either increase or decrease by 20%. Finally, the risk-free interest rate (simple, annualized) is 10% and ABC will not pay any dividend. What is the current market value of one put option?

Answer rating: 100% (QA)

To calculate the current market value of one put option we need to use the concept of riskneutral va... View the full answer