(Concept Problem) Suppose a stock is priced at $80 and has a volatility of 0.35. You buy a call option with an exercise price of $80 that expires in three months. The risk-free rate is 5 percent. Answer the following questions.
a. Determine the theoretical value of the call. Use Black Scholes Merton BinomiallOe.xlsm.
b. Suppose the actual call is selling for $5. Suggest a strategy, but do not worry about hedging the risk. Simply buy or sell 100 calls.
c. After purchasing the call, you investigate your possible profits. You expect to unwind the position one month later, at which time you expect the call to have converged to its Black-Scholes-Merton value. Of course, you do not know what the stock price will be, but you can calculate the profits for stock prices over a reasonable range. You expect that the stock will not vary beyond $60 and $100. Determine your profit in increments of $10 of the stock price. Comment on your results.