Consider the following. You hold an American call on company S that will expire in one year. The stock is currently priced in the market at 100, and your exercise price is 75. In six months the company will spin-off one of its subsidiaries, B. Note that the options will not be adjusted for the spin-off, and the shares you can buy with your options will not receive shares in B. Your company will, independent of your options position, own a 10% share in the new company B. Your company paid $15 for that position a month ago. Assuming that the volatility of S is 40%, what should be the price of this option? What assumptions do you have to make about this valuation? Can you apply Black-Scholes directly? If not, how do you have to modify it?
Wednesday, February 2, 2011
Stock Options - Black Scholes - American call
Consider the following. You hold an American call on company S that will expire in one year. The stock is currently priced in the market at 100, and your exercise price is 75. In six months the company will spin-off one of its subsidiaries, B. Note that the options will not be adjusted for the spin-off, and the shares you can buy with your options will not receive shares in B. Your company will, independent of your options position, own a 10% share in the new company B. Your company paid $15 for that position a month ago. Assuming that the volatility of S is 40%, what should be the price of this option? What assumptions do you have to make about this valuation? Can you apply Black-Scholes directly? If not, how do you have to modify it?
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