Consider a European call option on a non-dividend-paying stock; when the option

Question

Consider a European call option on a non-dividend-paying stock; when the option is written, the stock price is S0, the volatility of the stock price is , the strike price is K, the continuously compounded risk-free rate is r, and the term to expiration is T; let c be the price of the option. The Black-Scholes formula for the option price is

0 ( 1 )

c = S N d + Ke - rT N ( d 2 )

0 ( 1 )

c = S N d - Ke N d

rT     ( 2 )

0 ( 1 )

c = S N d - Ke - rT N ( d 2 )

0 ( 2 )

c = S N d- Ke-rTN(d1)

where N(x) is the cumulative probability distribution function for a standardized normal

distribution and d1 and d2 are parameters dependant on the structure of the option, the level of

interest rates, and the volatility of the stock price.

13.       (a) Using the terminology of the last question (re-printed above – Question 8 from the multiple choice section), specify the Black-Scholes formula for the price of a European put option on a non-dividend-paying stock

Explicitly describe the relationship of the parameters d1 and d2 to the structure of the option, the level of interest rates and the volatility of the stock price and the relationship of the parameters to each other; use the notation of the last question (e.g., write the formulas for d1 and d2 )

We found that for a dividend yielding stock that there was a simple enhancement possible to convert the result in question 3) to the case of a European call option on a dividend yielding stock. Let q represent the dividend yield and describe the enhancement (which we found appropriate in many representations). Also, show the result for the European call option on a dividend yielding stock (include the formula for d1 and d2 ).

Using the data above please answers all parts. Will give good rating.

Explanation / Answer

Correct Answers is C
c = S0*N (d1) – K*erT *N(d2)

Explaination for such answer

There is no need to remember this formula just understand it in parts for that see the above formula as = erT (S0*erT*N (d1) – K*N (d2))

Now you can see S0erT represents the future value of the stock and multiplying it by N(d1) puts a condition that  the end value of stock S(T) being higher than the strike price K

In the other term i.e. KN (d2) is the value of the known payment K multiplied with the probability that the strike price of stock will be paid in future i.e. N(d2).

Now whole formula inside the bracket is discounted using erT to get the value of call.  

Answer 13 (a)

Formula for value of put option is

p = -S0N (-d1) + ke-rtN (-d2)

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