Binomial Pricing: Consider Two Call Options Written on Different Stocks

question 12

Multiple Choice

Binomial pricing: Consider two call options written on different stocks. Both call options have a strike price of $15 and expire one year from today. The first option is written on LowVol Co., whose current stock price is $16. One year from now, shares of LowVol Co. will either rise to $18 or fall to $14. The second option is written on HighVol, Inc., whose current stock price is also $16. One year from now shares of HighVol Inc. will either rise to $22, or fall to $0. The risk-free interest rate is 0 percent. Which call option is worth more?

• A) The call option on LowVol is worth more.
• B) The call option on HighVol is worth more.
• C) They are both worth the same amount.
• D) There is not enough information to make a comparison.

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Definitions:

Cognitive Heuristic

Simple, efficient rules which people often use to form judgments and make decisions; they are mental shortcuts that reduce the cognitive load of making a decision.

Proposition

A statement or assertion that expresses a judgment or opinion.

Prototype

A typical or standard example of a particular concept or category, often used as a reference point for comparing other items in the same category.

Subconscious

The subconscious is a part of the mind that operates below the level of conscious awareness, influencing thoughts, feelings, and behaviors without our direct knowledge.