P15-16. Explain the following paradox. A put option is a highly volatile security. If the underlying stock has a positive beta, then a put option on that stock will have a negative beta (because the put and the stock move in opposite directions).
According to the CAPM, an asset with a negative beta, such as the put option, has an expected return below the risk-free rate. How can an equilibrium exist in which a highly risky security such as a put option offers an expected return below a much safer security such as a Treasury bill?
P15-17. A particular stock sells for $27. A call option on this stock is available, with a strike price of $28 and an expiration date in four months. If the risk-free rate equals 6 percent and the standard deviation of the stock's return is 40 percent, what is the price of the call option? Next, recalculate your answer assuming that the market price of the stock is $28. How much does the option price change in dollar terms? How much does it change in percentage terms?
P15-18. Temex Foods stock currently sells for $48. A call option on this stock is available, with a strike price of $45 and an expiration date six months in the future. The standard deviation of the stock's return is 45 percent, and the risk-free interest rate is 4 percent. Calculate the value of the call option. Next, use the put-call parity to determine the value of a Temex put option that also has a $45 strike price and six months until expiration.© BrainMass Inc. brainmass.com July 20, 2018, 1:09 am ad1c9bdddf
Answers to questions on put, call options