A stock with a current price of $30 will either move up to $37 or down to $26 over the next period.The risk-free rate of interest is 2.5 percent.What is the value of a call option with a strike price of $35?
A)$0.49
B)$0.68
C)$0.86
D)$0.97
E)$1.21

Question

Quizplus · Accepted Answer

The call option will be worth $2 if the stock moves up to $37 (since $37 - $35 = $2) and $0 if the stock moves down to $26. Using the risk-neutral probability approach and the risk-free rate, the value of the call option is calculated as follows:  Risk-neutral probability (p) = (1 + 0.025 - 26/30) / (37/30 - 26/30) = 0.5909  Call option value = [p * $2 + (1-p) * $0] / (1 + 0.025) = [$1.1818] / 1.025 = $0.86

A Stock with a Current Price of $30 Will Either