Problem:
You own a one-year call option on one acre of Los Angeles real estate. The exercise price for your option is $2,000,000. The current appraised market value of the land underlying your option is $1,700,000. The land is currently being used as a parking lot, generating just enough cash flow to cover the property taxes currently being assessed by the country. The standard deviation for the annual rate of growth in property values in Los Angeles County is 15 percent. The risk-free cost of borrowing to finance the purchase of the land is 9 percent. Use the Black-Scholes formula to approximate the value of the call option.