Question

23 (12/115) + C +0.5.1994)x 0:15] - •, 5.74 Vost- 1 9) DEF Stock has a current price of $52.50, standard deviation of 25%, beta of 1.25, and expected return of 20%. A DEF Call option has a strike price of $50, 2 months remaining until expiration, N[d,)=0.7293, N(D2)=0.6945, Bp=34.45, and a current price of $3.85. The continuously compounded (riskfree rate is 5%) What is the expected return to the call? 2 0. - 0 ) ( (529/50) filter 2497

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Answer 1

Solution:

Given Strike price = 50$ , Option Price = 3.85$

The expected return on the call option is nothing but:

(Projected Option Price - Option Price) / (Option Price)

Projected Option Price = Projected Stock Price - Strike Price of the call - Option Price

Projected Stock Price = Current Price X (1 + Expected Return)

= 52.50 * (1+20%)

= 52.50 * 1.2 = 63

Putting this value in the formula we get,

Projected Option Price = 63 - 50 - 3.85

= 13 - 3.85 = 9.15

Expected return on option = (9.15 - 3.85) / 3.85

= 5.3/ 3.85 = 1.3766

So, the expected return on the option is 137.66%