Question

 

1. The following information is given about options on the stock of a certain company. S0 = $341.00; X = $350.00; rc = 2.421%; T = 0.25; and volatility = 80.00%. No dividends are expected. Use this information to answer the following four questions. Assume 1 share per option contract. What value does the Black-Scholes-Merton option valuation model indicate for the call option? (Select the closest answer.)

   		32.22
   		45.15
   		51.22
   		54.11

2. Suppose you believe that the market call option is overpriced. As an arbitrageur, what strategy should you use to exploit the apparent errant valuation? (Select the closest answer and assume each call is for one share.)

		buy 560 shares, sell 1,000 calls
		sell 401 shares, sell 1,000 calls
		sell short 994 shares, buy 1,000 calls
		sell short 401 shares, buy 1,000 calls

3. Suppose you believe that the market call option is overpriced. As an arbitrageur, what strategy should you use to exploit the apparent errant valuation? (Select the closest answer and assume each call is for one share.)

		buy 560 shares, sell 1,000 calls
		sell 401 shares, sell 1,000 calls
		sell short 994 shares, buy 1,000 calls
		sell short 401 shares, buy 1,000 calls

Answer 1

1. Option C $51.22

2. Option A Buy 560 Shares and Sell 1000 Call Options

3. Option A Buy 560 Shares and Sell 1000 Call Options (2nd and 3rd are same)

Delta of Call Option = 0.560. Now we feel that the call option is overpriced so we use market to sell as many call otions as possible to offset the call option we buy Shares of Delta Value.