Option (20 Marks)

a) (10 Marks) You are attempting to value a call option with an exercise price of $100 and 1 year to expiration. The underlying stock pays no dividends. Its current price is $102.5 per share, and you believe it has a 50% chance of increasing to $115 and a 50% chance of decreasing to $85. The risk free rate of interest is 10%. Calculate the call options value using the two-state stock price model.

b) (4 Marks) As of now, Given the above conditions on the option, what is the intrinsic value of the call option? What is the time value of the call option?

c) (6 Marks) If you buy one call at the price equals the above calculated value (assume the traded call price = call option value you calculated in a)), at what stock price you will be break-even on the option expiration date? (2 marks). If stock price rises to $150 per share on the option expiration date, what is your rate of return? (2 marks). If stock price drops to $80 per share on the option expiration date, what is your rate of return? (2 marks)