One year from now, a stock is expected to be priced at either $36 or $49. Currently the stock is selling for $38.20 while Treasury bills are yielding 2.5%. What is the value of a twelve-month call option with an exercise price of $40?
A) $0
B) $1.44
C) $2.13
D) $3.08
E) $4.45

Question

Quizplus · Accepted Answer

The call option will only be exercised if the stock price is above $40. If the stock price is $49, the payoff is $9 ($49 - $40). If the stock price is $36, the payoff is $0. Using the risk-neutral probability approach and discounting at the risk-free rate, the call option value is calculated to be approximately $2.13.

One Year from Now, a Stock Is Expected to Be