What is bigger: 17.5% or 1/6?
1 answer:
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Answer:
Step-by-step explanation:
An option to buy a stock is priced at $150. If the stock closes above 30 next Thursday, the option will be worth $1000. If it closes below 20, the option will be worth nothing, and if it closes between 20 and 30, the option will be worth $200. A trader thinks there is a 50% chance that the stock will close in the 20-30 range, a 20% chance that it will close above 30, and a 30% chance that it will fall below 20.
a) Let X represent the price of the option
<h3><u> x P(X=x) </u></h3>
$1000 20/100 = 0.2
$200 50/100 = 0.5
$0 30/100 = 0.3
b) Expected option price
Therefore expected gain = $300 - $150 = $150
c) The trader should buy the stock. Since there is an positive expected gain($150) in trading that stock option.