Question

please answer question 10

 10. The current price of an American call option with one year to expiration is $10. The stock on which the call is written is selling at $65 and the exercise price of the option is $55. The risk-free rate is 8% per year. What would you rather do: i. sell the option now and invest the proceeds in the risk-free asset, or ii. sell the stock short, invest the proceeds in the risk-free asset and wait till expiration to exercise the option? Show the end of year cash flows to justify your choice.

Answer 1

Detail provided : C = 10, So = 65, K = 55, Rf = 8%

Option 1:

10*e^(8%*1) = 10.83287

Option 2 :

65*e^(8%*1) - 55 = 15.41366

Hence option 2 is more valuable