Suppose that the result of a major lawsuit affecting a company is due to be announced tomorrow. The company's stock price is currently $60. If the ruling is favorable to the company, the stock price is expected to jump to $75. If it is unfavorable, the stock is expected to jump to $50. What is the risk-neutral probability of a favorable ruling?
Assume that the volatility of the company's stock will be 25% for 6 months after the ruling if the ruling is favorable and 40% if it is unfavorable.
Use DerivaGem to calculate the relationship between implied volatility and strike price for 6-month European options on the company today.
The company does not pay dividends. Assume that the 6-month risk-free rate is 6%. Consider call options with strike prices of $30, $40, $50, $60, $70, and $80.