Question 3 (3 marks)

Let the standard deviation of the continuously compounded return on the stock be 20 percent.

Ignore dividends. Respond to the following:

a. What is the theoretical fair value of the October 165 call. Calculate this answer by

hand and then re-calculate it using BlackScholesMertonBinomial10e.xlsm.

b. Based on your answer in part a, recommend a riskless strategy.

c. If the stock price decreases by $1, how will the option position offset the loss on the

stock?

Question 4 (3 marks)

Use the Black-Scholes-Merton European put option pricing formula for the October 160 put

option. Repeat parts a, b and c of Question 3 with respect to the put.