You are attempting to value a call option with an exercise price of $105 and 1 y

Question

You are attempting to value a call option with an exercise price of $105 and 1 year to expiration. The underlying stock pays no dividends, its current price is $105, and you believe it has a 50% chance of increasing to $122 and a 50% chance of decreasing to $88. The risk-free rate of interest is 10%. Calculate the call option's value using the two-state stock price model. (Do not round intermediate calculations and round your final answer to 2 decimal places. Omit the "$" sign in your response.) Call option's value

Explanation / Answer

payoff values in year1

upside = Max(122-105,0) = 17

downside = max(88-105,0) = 0

Call = ( Pu * Upside + Pu * downside ) / (1 + Risk free rate)

Call = (0.5*17 + 0.5*0) / (1 + 10%) = 7.73

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