It has been determined that 0.5 shares of stock should be purchased with borrowed funds to replicate the payoff to one call option.What is the option's strike price if the stock could range in value from $110 to $10 at the expiration of the option?
A)$40
B)$50
C)$60
D)$70

Question

Quizplus · Accepted Answer

To replicate the payoff to one call option, we need to purchase 0.5 shares of stock with borrowed funds. The range in value of the stock at expiration is from $10 to $110. Therefore, the strike price of the option must be in the middle of this range, which is $60. At the strike price of $60, if the stock price is above $60, the option will be in-the-money and the payoff will be greater than the cost of buying 0.5 shares of stock. If the stock price is below $60, the option will be out-of-the-money and the payoff will be zero, but we only lose the cost of buying 0.5 shares of stock. Therefore, $60 is the best choice for the strike price.

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