Question of the Week

ABC shares are currently trading at $27.00, and they are expected to pay a dividend of $0.50 in 6 month's time. The 6- month put option on ABC shares with an exercise price of $25.00 is currently trading at $1.50. If the risk-free rate is 8%, what should be the value of a 6-month call option on ABC shares with an exercise price of $25.00?

a) $2.82
b) $2.00
c) $2.87
d) $3.96


Answer: The correct answer is d)

According to Put-Call Parity:

(Stock Price) + (Put) - (Call) = PV(X) + PV(D)

27.00 + 1.50 - c = [(25)/(1.08)0.5] + [(0.50)/(1.08)0.5]

28.50 - c = 24.06 + 0.48
           c = $3.96