The Case of Cephalon
Based on the contract, the strike of the call options is $21.5, and capped at $39.5. Thus this is a combination of a call option at $21.5 and a put option at $39.5 two options, and the value is the difference between the two. Based on the Balck-scholes call formula,
among which, ；
1）The price of call option with the strike price of $21.5: S=$20;K=$21.5;r=5.5%;T-t=0.5yrs;σ=75%
2）The price of put option with the strike price of $39.5:
The price of the capped calls should be $3.83-$0.75=$3.08, and the value of the options $3.08*2500000=$7.7 million By using the Black-Scholes formula, there are several important features being ignored for this proposed option contract. First, this option contract has an Asian feature that the Black-Scholes model is not built to handle. In the contract, the options' payoff at maturity is determined by the spread between the exercise price and the stock's average price over the 20 days prior to exercise, with three readings taken a day. This averaging feature would tend to reduce the value of the options. Second, these options are being bought by a firm on its own stock, so in effect they are negative warrants due to the negative dilution effect. This anti-dilution would tend to increase the value of the position acquired by Cephalon. Third, and most importantly, Cephalon faces an uncertainty which will affect the stock price at a very large level. Because one day after the option contract is signed, the FDA advisory panel recommendation will be issued. The stock price may jump largely, effectively increasing the volatility of the stock and increases the option value. It also means that the true distribution of returns is bimodal. Fourth, from January 1996 to May 1997, the skewness of Cephalon's daily log stock returns is -1.13 (0.26), while the kurtosis is 15.54 (0.13). These values are significantly different from those expected for a normal...
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