Value of Investment at Year-end 1 (i) When Shares are Purchased and (ii) When Call Options are Purchased in Conjunction with Treasury Bills.
Since both the alternatives have the same financial returns, they must a priory have the same value today or it will cause arbitrage opportunity. Since the current price of the share is Rs 125. the value of the call option today (C0) is logically given by Equation 5.10.
The value of call option has to be Rs 3.45 is shown in verification Table. The investment outlay under both the alternatives is the same.
Value of Call Option
From Equation 5.10. follows the generalization that the value of a call option is the current market price of share less the present value of exercise price (discounted at risk-free rate of return). To put it differently, the value of call option is a function of (i) current share price, So. (ii) exercise price E, (iii) risk-free rate of return. R and (iv) time to expiration t. The impact of these factors on call option value is now explained.