Exhibit 22.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The information provided is relevant in the context of a one period (one year) binomial option pricing model. A stock currently trades at $50 per share, a call option on the stock has an exercise price of $45. The stock is equally likely to rise by 25% or fall by 25%. The one-year risk free rate is 2%.
-Refer to Exhibit 22.5. Estimate n, the number of call options that must be written.
A)-1.4286
B)-2.9286
C)-2.8571
D)-2.5714
E)-1.1111

Question

Quizplus · Accepted Answer

The correct answer is A because the number of call options that must be written is -1.4286. This is because the call option is out of the money, and the stock is equally likely to rise or fall. Therefore, the expected value of the call option is negative, and the number of call options that must be written is negative.

Exhibit 22.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)