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Suppose that Bigco is currently trading for $100 per share. We know that in one year Bigco

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Suppose that Bigco is currently trading for $100 per share. We know that in one year Bigco stock will sell for either $150 per share (“good day”) or for $75 per share (“bad day”). No other prices are possible, and the stock does not pay any dividends. The riskless interest rate is 5 percent, so a bond worth B1 next year sells for B0 = B1/(1 + r) today. Stocks, bonds, and options can all be bought or sold, long and short, without any transaction costs.

(a) What is the value of a European call option with a strike price of $100 and expiration in one year?

(b) What is the value of a European put option with a strike price of $100 and expiration in one year?


Strike Price
In finance, the strike price of an option is the fixed price at which the owner of the option can buy, or sell, the underlying security or commodity.
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a Call Good day profits 150100 50 Bad day profits 75...View the full answer


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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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