Case 10 OPTIONS CASE General Synergistics is an emerging leader in the development of bioengineering technology. Since its stock is relatively volatile and draws a large amount of investor interest, the firm has recently been listed on the Chicago Board of Options Exchange (CBOE), and put and call options on the firms stock are now being traded. The listing has generated a lot of interest among the firms senior managers, but only a few of them have a good understanding of what options are and how they work. As a service to the firms senior managers, General Synergistics chief financial officer, Rex Moncrief, plans to hold a seminary on the basic of option theory and valuation. Mr. Moncrief has asked you, a newly hired financial analyst, to make the presentation. To help you get started, Moncrief has supplied you with the following set of questions. See if you can answer them. 1. What is an option? 2. Suppose General Synergistics, which is currently trading at $28, has 3-month put and call options with a striking price of $25. The call option currently sells for $4.50 per share while the put option costs $1.50 per share. (1) What is the minimum number of shares in a stock option contract? (2) Is the call option in or out of the money? What about the put option? 3. Again consider General Synergistics call option with a $25 striking price. The following table contains historical values for this option at different stock prices: Stock Price Call Option Price $25 $ 3.00 30 7.50 35 12.00 40 16.50 45 21.00 50 25.50 (1) Create a table which shows (a) stock price, (b) striking price, (c) expiration value, (d) option price, and (e) the premium of option price over expiration value. 4. In 1973, Fischer Black and Myron Scholes developed the Black-Scholes Model (OPM). (1) What assumptions underlie the OPM? (2) Write out the three equations that constitute the model. (3) What is the value of the following call option according to the OPM? Stock price = $28.00 Exercise price = $25.00 Time to expiration = 3 months Risk-free rate = 5% Stock return variance = 0.38 5. What impact does each of the following call option parameters have on the value of the option? (1) Current stock price (2) Exercise price (3) Option period (4) Risk-free rate (5) Stock return variance