The stock price of Heavy Metal (HM) changes only once a month: either it goes up by
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The stock price of Heavy Metal (HM) changes only once a month: either it goes up by 20% or it falls by 16.7%. Its price now is $40. The interest rate is 12.7% per year, or about 1% per month.
a. What is the value of a one-month call option with an exercise price of $40?
b. What is the option delta?
c. Show how the payoffs of this call option can be replicated by buying HM’s stock and borrowing.
d. What is the value of a two-month call option with an exercise price of $40?
e. What is the option delta of the two-month call over the first one-month period?
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