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ACCA Strategic Professional · Advanced Financial Management · Application of option pricing theory in investment decisions

A share is priced at $80 and will pay a dividend before the options expire, with a present value of $3. A European put with an exercise price of $75 and a present value of exercise price of $70 is trading at $5. Assuming parity holds for options on a dividend-paying share, what is the value of the European call with the same terms?

The call is worth $12. For a dividend-paying share, the share price is reduced by the present value of dividends before applying parity: call = put + (80 - 3) - 70 = 5 + 77 - 70 = $12. Ignoring the dividend would overstate the call at $15.

  1. A$15
  2. B$18
  3. C$12Correct
  4. D$7

Explanation

Adjusted parity: C - P = S - PV(dividends) - PV(X). C = 5 + 80 - 3 - 70 = $12. Ignoring the dividend gives $15. Adding the dividend gives $18. Using the undiscounted exercise price of $75 gives $7.

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