The common shares of networking giant Cisco Systems, Inc. (CSCO) recently traded
ID: 363350 • Letter: T
Question
The common shares of networking giant Cisco Systems, Inc. (CSCO) recently traded on NASDAQ for $22.64 per share. You have employee stock options to purchase 1,00o csco shares for $22 per share. The options expire in three years. The annualized volatility of CSCO stock according to Robert's Historical Stock Volatities (www.intrepid.com/robertl/stock- vols1.html) in a recent month was 31.41 percent. The company's dividend yield is 3.0 percent, and the interest rate is 2.5 percent. (Assume the options are European options that may only be exercised at the maturity date.) a. Is this option a call or a put? b. Using Robert's Option Pricer (www.intrepid.com/robertl/option-pricer1.html) or any other calculator you prefer, estimate the value of your CSCO options. c. What is the estimated value of the options if their maturity is five months instead of three years? Why does the value of the options decline as the maturity declines? d. What is the estimated value of the options if their maturity is three years, but CSCO's volatility is 45 percent? Why does the value of the options increase as volatility increases?Explanation / Answer
1. As I have the right to buy the stock, it is call option
2. $4.55 per option so 1000 options=4.55*1000=$4550
3. $2.09 per option so 1000 options = 2.09*1000 = $2090
4. The increase in volatility causes an increase in option value.
Implied volatility is a concept specific to options and is a prediction made by market participants of the degree to which underlying securities move in the future. Implied volatility, essentially, is the real-time estimation of an asset’s price as it trades. This provides the predicted volatility of an option’s underlying asset over the entire lifespan of the option, using formulas that measure option market expectations. When option markets experience a downtrend, implied volatility generally increases. Conversely, market uptrends usually cause implied volatility to fall. Higher implied volatility indicates that greater option price movement is expected in the future.