Over the coming year Ragwort’s stock price will halve to $50 from its current level of $100 or it will rise to $200. The one-year interest rate is 10%.
a. What is the delta of a one-year call option on Ragwort stock with an exercise price of $100?
b. Use the replicating-portfolio method to value this call.
c. In a risk-neutral world what is the probability that Ragwort stock will rise in price?
d. Use the risk-neutral method to check your valuation of the Ragwort option.
e. If someone told you that in reality there is a 60% chance that Ragwort’s stock price will rise to $200, would you change your view about the value of the option? Explain.