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.
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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