Question

You are attempting to value a call option with an exercise price of $104 and one year to expiration. The underlying stock pays no dividends, its current price is $104, and you believe it has a 50% chance of increasing to $118 and a 50% chance of decreasing to $90. The risk-free rate of interest is 11%. Calculate the call option’s value using the two-state stock price model.

Answer 1

Using excel to calculate call option at year 0

Stock Value	104
Risk free Rate	11%
Probability of Up	50%
Probability of Down	50%
			S1+	118
			C1+	14	(Max Value of (0,S1-S0)
Stock Value(S0)	104
			S1-	90.00
			C1-	0.00	(Max Value of (0,S1-S0)
Call option in Year 1	7.00	(Formula = Probability of Up*C1 + Probability of Down * C1-)
Cal option at year 0	6.31	Formula= Call oprtion at year 1/(1+r)

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