Based on today's quote for ABC stock and option with 6 months to expiration:

Current stock price for ABC: 100

Stock pays no dividends.

Strike price of call option: 97

Annual risk-free rate: .03

Expected return of stock (arith mean): .12

Standard deviation (volatility) of annualized return: .3

Market price of call option: 10

1. Use the binomial model and follow the steps below to estimate the theoretical price of the above ABC call option. Assume that the stock price can either rise to 120.62 or drop to 89.36 in 6 months.

a. Calculate delta.

b. Calculate the theoretical price of call with the binomial model.

c. According to your result, is the call currently over or underpriced?

2. Now we switch to the Black Scholes Model for pricing the previous ABC option.

a) Calculate N(d1) in the BS Model.

b) Estimate the value of the ABC call option with the BS Model.

3. Using the same data for ABC from above. Estimate the expected price of the ABC stock 6 months from now using the continuous return approach. (ignore Binomial Model)

Answer rating: 100% (QA)

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