Reference no: EM133057177
Consider Zoom stock currently trading for $260 per share. Over a six-month period, the price will either increase by 20% (u = 1.2) or decrease by 10% (d = 0.9). The annualized continuously compounded three-month interest rate, r = 0.5%.
a) What is the value of a European put option on Zoom with a time to maturity of 6 months and an exercise price of $265?
b) Suppose that the true, expected annual stock price return (and discount rate) for Zoom was 10% so that E[ST] = S0e^(0.1 x 0.5), calculate the real world probabilities of an up and down movement?
c) Using these real world probabilities probabilities, determine the real world expected return for the European put option above. Does the answer surprise? Can explain it?
d) What happens to this expected return as we vary the exercise price of the European put option? Consider a few different cases (consider, say $200, $220, $240, $260, $280, $300, ...) and explain the different expected return values.
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