ABC Inc stock is launching a new product tomorrow and a trader wishes to exploit this opportunity by holding options. The current stock price is trading at $30. The trader following the stock expects the news to cause the volatility over the next three months to be either 10% or 40%. He believes that there is a 30% chance of the first outcome and a 70% chance of the second outcome. The trader calculates the call prices for three-month options using 10% and 40% volatility. Then using the weighted-average price (from the two prices), the trader creates the implied volatilities. The output table is in the following: C Implied Volatility of the Weighted Average Price (of Columns A and B) 25.53 23.13 20.77 19.80 20.68 Strike price Call Price (calculated with 10% Vol) Call Price (calculated with 40% Vol) 24 26 6.519 4.358 6.943 5.224 28 30 32 34 2.341 0.867 0.195 0.025 0.002 3.765 2.598 1.716 1.087 0.661 22.67 24.6 36 O Discuss the characteristics of the options markets from the output table.

ABC Inc stock is launching a new product tomorrow and a trader wishes to exploit this opportunity by holding options. The current stock price is trading at $30. The trader following the stock expects the news to cause the volatility over the next three months to be either 10% or 40%. He believes that there is a 30% chance of the first outcome and a 70% chance of the second outcome. The trader calculates the call prices for three-month options using 10% and 40% volatility. Then using the weighted-average price (from the two prices), the trader creates the implied volatilities. The output table is in the following: C Implied Volatility of the Weighted Average Price (of Columns A and B) 25.53 23.13 20.77 19.80 20.68 Strike price Call Price (calculated with 10% Vol) Call Price (calculated with 40% Vol) 24 26 6.519 4.358 6.943 5.224 28 30 32 34 2.341 0.867 0.195 0.025 0.002 3.765 2.598 1.716 1.087 0.661 22.67 24.6 36 O Discuss the characteristics of the options markets from the output table.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter5: Financial Options

Section: Chapter Questions

Problem 4MC

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