12. Buffelheads stock price is $220 and could halve or double in each six-month period (equivalent to

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12. Buffelhead’s stock price is $220 and could halve or double in each six-month period

(equivalent to a standard deviation of 98%). A one-year call option on Buffelhead has an exercise price of $165. The interest rate is 21% a year.

a. What is the value of the Buffelhead call?

b. Now calculate the option delta for the second six months if (i) the stock price rises to

$440 and (ii) the stock price falls to $110.

c. How does the call option delta vary with the level of the stock price? Explain intuitively why.

d. Suppose that in month 6 the Buffelhead stock price is $110. How at that point could you replicate an investment in the stock by a combination of call options and risk-free lending? Show that your strategy does indeed produce the same returns as those from an investment in the stock.

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Related Book For  book-img-for-question

Principles Of Corporate Finance

ISBN: 9780071314176

10th Global Edition

Authors: Richard Brealey

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