Question
The one year call option on Caddo Inc. stock has an exercise price of 45. The...
The one year call option on Caddo Inc. stock has an exercise price of 45. The current value of Caddo is 46. On the maturity date, the value of Caddo will be either 51 or 43. The risk free rate is 5%. Use the binomial option pricing model to find a fair value for the call option.
Homework Answers
Answer #1
Probability for the Higher Price:
CMV = Current market value as on today
i = interest rate
Probability for the price-51 :
Therefore Probability for the price-43 = 1 - 0.6625
= 0.3375
Value of Call Option at maturity date:
(i) If price will be 51:
Value of call option = Market Value - Exercise Price
= 51 - 45
= 6
(ii) If price will be 43:
Value of call option = Market Value - Exercise Price
= 43 - 45
= 0 [Value can not be negative]
Fair Value of Call Option as on today:
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