Question
Your Aunt Betty has a $120,000 investment portfolio comprising some Government of Canada three-month Treasury Bills and 2,000 Suncor shares. When the portfolio was formed
Your Aunt Betty has a $120,000 investment portfolio comprising some Government of Canada three-month Treasury Bills and 2,000 Suncor shares. When the portfolio was formed (one month ago), the shares were worth $85,700 and the bonds were worth $34,300. Today, Suncor shares are worth $41.94 per share, while the bond yields have decreased so that the bonds are now worth $38,000. The effective yield on the three-month Canada Treasury Bill is 0.94% per annum.
Aunt Betty is a bit concerned about the drop in value of her Suncor shares and consequently, her overall portfolio value. Knowing that you are taking a finance course, she consults you to see what she can do to protect her portfolio from a further drop in value. She has heard a lot about call and put options and would like to know more about these.
You immediately go online to look for information on options on Suncor shares. You find the following pricing information on the call options (Table 1) and the put options (Table 2) on Suncor, with expiry in one month:
Table 1: Call option prices
Strike | Last | Chg | Bid | Ask | Vol | Open Int |
41.50 | 0.43 | 0.01 | 0.42 | 0.45 | 98 | 96 |
42.00 | 0.33 | +0.13 | 0.36 | 0.39 | 101 | 38 |
42.50 | 0.12 | +0.02 | 0.10 | 0.16 | 62 | 11 |
43.00 | 0.05 | 0.00 | 0.05 | 0.08 | 2 | 12 |
Table 2: Put option prices
Strike | Last | Chg | Bid | Ask | Vol | Open Int |
40.50 | 0.10 | 0.00 | 0.09 | 0.10 | 5 | 5 |
41.00 | 0.06 | 0.18 | 0.04 | 0.06 | 10 | 12 |
41.50 | 0.13 | 0.18 | 0.10 | 0.13 | 48 | 57 |
42.00 | 0.39 | 0.48 | 0.30 | 0.39 | 91 | 1 |
42.50 | 1.22 | 0.00 | 1.00 | 1.25 | 64 | 64 |
Upon further research, you find that there are two other 42-call options which expire in two and three months, respectively. Suppose Aunt Bettys projections of down- and up-movements of Suncor remain the same for up to three months. What are the theoretical call prices of these two 42-call options based on the Binomial Model? Are these prices higher or lower than the price of the 42-call that expires in one month?
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