Chapter 22 Problem 1 pg 841You are considering the sale of a
call option with an exercise price of $100 and one year to
expiration. The underlying stock pays no dividends, its current
price is $100, and you believe it will either increase to $120 or
decrease to $80. The risk-free rate of interest is 10
percent.a.Describe the specific steps involved in applying the
binomial option pricing model to calculate the option’s
value.b.Compare the binomial option pricing model to the
Black-Scholes option pricing model.

Donna Donie, CFA, has a client who believes the common stock
price of TRT Materials (currently $58 per share) could
move substantially in either direction in reaction to
an expected court decision involving the company. The
client currently owns no TRT shares but asks Donie for advice about
implementing a strange strategy to capitalize on the
possible stock price movement. Donie gathers the TRT
option pricing data shown in the following table:

TRT Materials Option Pricing Data (USD)

Characteristic

Call Option

Put Option

Price

5

4

Strike Price

60

55

Time to expiration

90 Days from now

90 Days from now

a. Recommend whether Donie should choose a long strangle
strategy or a short strangle strategy to achieve the
client’s objective. Justify your recommendation with
ONE reason.

b. Indicate at expiration for the appropriate strangle
strategy in Part a, the :

1 Maximum possible loss per share

2 Maximum possible gain per share

3 Breakeven stock price(s)

Note: Your responses should ignore taxes and transaction
costs.

The delta of the call option is 0.625 and TRT common stock
does not pay any dividends.

c. Calculate the appropriate change in price for the call
option if TRT’s stock price immediately increases to
$59.

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