Stock ABC and Stock XYZ have the same current price of $50, and they offer the s

Question

Stock ABC and Stock XYZ have the same current price of $50, and they offer the same distribution of future returns (with the same expected return and the same standard deviation). There exists a call option on one share of Stock ABC and a call option on one share of Stock XYZ. The options have identical exercise prices of $49 and they expire on the same date. The call premium on each option is $3.

A.) Are the options currently “in” or “out” of the money?

B.) What is the intrinsic value and the time value of each option today?

C.) What is the break-even future stock price associated with the options?

D.) What is the net profit or loss associated with purchasing either option if the future stock price is $30.

E.) What is the net profit or loss associated with writing either option if the future stock price is $48?

F.) What is the net profit or loss associated with writing either option if the future stock price is $51?

G.)What is the net profit or loss associated with writing either option if the future stock price is $80?

H.) Assume that there is a third call option, based on the average price of Stocks ABC and XYZ, with the same expiration date as the first two options. The exercise price of this option is $49. Should the price (call premium) of the third option be higher than, lower than, or equal to the prices of the two options on the individual stocks in the following two cases? (Briefly explain your answer in each case).

-The correlation between the returns of the ABC and XYZ is +1

-The correlation between the returns of the two stocks is +0.3

Explanation / Answer

Question Answer A "In" the money. B Intrinsic Value = 50-49 = $1 Time Value =$3-$1 = $2 C $49+$3 = $52 D. Net Loss $22 (=$52-30) E Net Loss $4 (=$52-48) F Net Loss $1 (=$52-51) G Net Gain $28 ($80-$52) H Correlation of +1 means "if value of one stock increased, Value of Other share also increased. So there is a chance of same price. Correlation of +0.30 is week relationship in between two Stock. So, Prices are not equal in this situation

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