Question 2

a. A call option has an exercise price of $45. If the premium of the call is $6.00, determine the options intrinsic value and time value, if the stock price is at

i. $45

ii. $50

iii. $40

For each of the case, determine whether the call option is in-the-money (ITM), at-the-money (ATM) or out-of-the-money (OTM).(15 marks)

b.

A put option on a stock with a current price of $43 has an exercise price of $47. The price of the corresponding call option is $2.25. According to put-call parity, if the effective annual risk-free rate of interest is 4.5% and there are three months until expiration, determine the value of the put option.

(9 marks)

c. Consider a call option with an exercise price of $105 and one year to expiration. The underlying stock pays no dividends and its current price is $100. The (risk-neutral) probabilities are a 50% chance of the stock price increasing to $130 and a 50 % chance of the stock price falling to $80. The risk free rate of interest is 4.75 % (per period). Determine the value of the option using the one-period binomial option pricing model.(20 marks)

d. With reference to c, suppose the (risk-neutral) probabilities are a 50% chance of the stock price increasing to $150 and a 50 % chance of the stock price falling to $50. Provide recommendation to buy or sell the call option. Justify your answer.(6 marks)