Question

5. Suppose that on January 18, 1994, Lotus’s stock was valued at $75.00 per share instead of $55.00. What is the very least you would expect to pay for the February 1994 call option exercisable at $55? What is the most? In general, what factors should enter into a determination of the appropriate price to pay?

Answer:

A forward contract with a delivery price of $ 55 would be worth 75-55*exp.(-rt)

An option with this strike price is worth that much because of the underlying value of the options. And for this reason you would pay 75-55*(-r*T). In addition the option cannot pay of more than the particular stock so for that reason you would not pay more than 75$. Most of the time option values are affected by the price of the underlying , as well as strike price and the volatility of the underlying stocks.

The time maturity and risk free return or rate and the dividends paid by the stocks.

6. Compare the prices of options on Lotus’s stock and those on AT&T’s. Why are options with identical exercise prices and maturity dates, and written on stocks with identical prices, selling for different prices? Do options on one of these two stocks provide investors with superior investment opportunities in comparison to the other?

Answer:

As we can see there is already given the factors that affect the option value .

All the factors are almost same between the two options expect the volatility of the underlying stock as well as dividends . As given that both the calls and puts on Lotus stock are more valuable we can derived that Lotus stock must be more volatile that AT&T for sure.

Hence it is not the necessary that the case which one provide superior investment opportunity . In real if both are priced suitably given their characteristics then neither of them is superior to the another one.