On 14th April 2022, Elon Musk offered to buy Twitter at a price of $54.20 per share.

This represented a 38% premium on the closing price of the share on 1st April, the final trading day before Musk bought a majority stake in the company:

 

2a) Do you think that the binomial options pricing model is a good model to describe this context? In this model, what would be the 'up' and 'down' scenario in the Twitter share price? Explain your reasoning. (Suppose the up scenario is 20% and the down scenario is also 20%)

 

2b) The Twitter share price fluctuated in quite a wide band in between Musk initial making the proposal to buy the company and the deal closing, as the market tried to assess the likelihood that he might pull out of the deal.

Calculate the price of a call option on Twitter shares, using the 'up' and 'down' scenarios suggested in part 2a) (Suppose the up scenario is 20% and the down scenario is also 20%), and with the following characteristics:

 

Date of Call option purchased: 25 August 2022 Twitter Share Price on 25 August 2022: $41

Date of expiry: 28th October (Day after deal closed) Risk Free Interest rate (Fed Funds rate): 2.5%

K (Strike price or exercise price) = $41