Question

The volatility of an asset’s return can be broken into diversifiable (i.e., unsystematic or firm-specific) and non-diversifiable (i.e., systematic) components. Investors who hold the asset should be compensated only for the non-diversifiable risk, which is measured by the “beta” of the asset. A stock that has a zero beta has no systematic risk and its expected rate of return should equal the risk-free rate. Suppose that you have two different stocks:

• S&P 500, which has a beta of 1.00 and 100% of its volatility is non-diversifiable; 

• CURE Inc., which is developing a new cure for cancer, which has a zero beta 
because 100% of its volatility is firm specific and thus diversifiable. 


BOTH stocks have IDENTICAL stock price trees (each is currently priced at $50 a share, and in one period it will be worth either $45 or $55). 
How would the differences in their betas affect the current prices of their call and put options? EXPLAIN. 


Answer 1

Beta measures the risk(Volatility) of an individual asset relative to the Market portfolio.Asset with Beta greater than 1 are called aggressive assets and one with beta as 0 are risk free assets therefore Stock with Beta therefore Stock with beta greater than 1 might go up or down agressively and stock with Beta 0 will be more stable. Now call options will be bought as the trader expects the price of the underlying to rise within a certain time frame.Stock cana rise indefinitely and so will be the value of options