Consider a call option with strike price of 2.5. Underlying stock is expected to follow the...

Consider a call option with strike price of 2.5.

Underlying stock is expected to follow the distribution:

Price Prob

1 0.05

2 0.20

3 0.25

4 0.25

5 0.20

6 0.05

1. When stock price is above the strike price of 2.5, what is the average value of the stock?

(hint: first find conditional probabilities and then find weighted average)

2. What is the average payment from the call option when the call option is in the money (ie stock price is above strike price of 2.5)?

(Hint: two ways to solve for this. a. weighted avg pmt of call option using conditional probabilities; b. just take the difference b/w conditional mean price of the stock and the strike price)

3. how much should the call be priced today (hint: this is asking for the unconditional mean of call option payment)

Solutions

Expert Solution

orchestra answered 1 year ago

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