Question
You are studying Flotec, a manufacturer of water process control equipment. The company is in the midst of a protracted lawsuit that alleges negligence. The
You are studying Flotec, a manufacturer of water process control equipment. The company is in the midst of a protracted lawsuit that alleges negligence. The stock currently trades at $45. You believe that a favorable ruling will drive Flotec's stock price up to $60, while on an unfavorable ruling the stock will drop to $30. You are considering purchasing an at the money straddle with a 360-day expiration. The current risk-free rate is 5.50%. You estimate the volatility to be .40. Please show all calculations in Excel
1. Using Black Scholes, what do you estimate is the price of each call option today?
2. Using Black Scholes, what is the price of each put?
3. At current market quotations you notice that the call price is 8.5 and the put price is 6. Based on your estimate of volatility and your calculations, are the options over or under-valued?
4. If you buy options on 1,000 shares at quoted prices for each, what will be the combined premium that you will pay?
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