We looked at the following example of a stock with a spot price of $100 and no dividends or carrying costs. - We characterized the volatility of the stock using the parameters u=1.5 and d=2/3. Note that these are inverses. - We assumed the risk-free rate was 3%, satisfying the relationship. u>(1+r)>dor1.5>1.03>2/3 The result is a risk neutral probability of q=(1+rd)/(ud)=0.436. Finally, we considered the risk neutral distribution for a three-period model (T=3) and used it to value a call with a strike of $125. I refer to this as the baseline model. The model resulted in a premium of $23.48 (rounded). Slides 3440 show more detail about the technique. PowerPoint Slides Used in Class (link) This question illustrates the leverage benefit of using options. A. An investor has $1 million to invest. How many shares of stock can they purchase, and what is the profit if the spot share price moves from $100 to $337.50 ? B. Alternatively, the investor uses the $1 million to buy call options at the premium shown above. How many calls can they purchase, and what is the profit if the spot share price moves from $100 to $337.50