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3 June, 07:27

Warnes Motors' stock is trading at $20 a share. Three-month call options with an exercise price of $20 have a price of $1.50. Which of the following will occur if the stock price increases 10% to $22 a share?

a. The price of the call option will increase by $2.

b. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.

c. The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.

d. The price of the call option will increase by more than $2.

e. The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.

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  1. 3 June, 08:10
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    B. The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.

    Explanation:

    Given

    Trading price = $20

    Exercise price of call option = $20

    Call option price = $1.50

    Price increment = 10% to $22

    It's not be noted that the discounted present value of a price of an option is represented by its expected payoff.

    An increment of $2 in stock price attracts an increment of more than $2 in the payoff option.

    Having highlighted that, it's also to be noted that the increment in expected payoff will be by an amount less than $2 and same with present value because the possibility is less than 1. So, the price of the option will increase by less than $2.

    Moving to the percentage increase;

    This will be larger than 10%.

    This is because when stock price increases by 10%, the value of the option will increase by more than 10%.
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