14. The common shares of networking giant Cisco Systems, Inc. (CSCO) recently tr

Question

14. The common shares of networking giant Cisco Systems, Inc. (CSCO) recently traded on NASDAQ for $22.64 per share. You have employee stock options to purchase 1,000 CSCO shares for $22 per share. The options expire in three years. The annualized volatility of CSCO stock according to Robert’s Historical Stock Volatilities (www.intrepid.com/robertl/stock-vols1.html) in a recent month was 31.41 percent. The company’s dividend yield is 3.0 percent, and the interest rate is 2.5 percent. (Assume the options are European options that may only be exercised at the maturity date.)

a. Is this option a call or a put?

b. Using Robert’s Option Pricer (www.intrepid.com/robertl/ option-pricer1.html) or any other calculator you prefer, estimate the value of your CSCO options.

c. What is the estimated value of the options if their maturity is five months instead of three years? Why does the value of the options decline as the maturity declines?

d. What is the estimated value of the options if their maturity is three years, but CSCO’s volatility is 45 percent? Why does the value of the options increase as volatility increase

Explanation / Answer

1. As I have the right to buy the stock, it is call option

2. $4.55 per option so 1000 options=4.55*1000=$4550

3. $2.09 per option so 1000 options=2.09*1000=$2090

The closer it is to expiration, more of move in underlying security is required to impact option’s price hence option price decreases with decrease in maturity

4. $6.37 per option so 1000 options=6.37*1000=$6370

When market expects little movement of stock, option’s time value is lower. Volatile stocks create higher time value. Hence, higher time value translates to higher option price. SO price of options increase as volatility increase.

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