Matt is interested in buying a European call option written on Air France SA, a non-dividend-paying equity, with a strike price of £110 and one year until expiration. Currently, Air France’s equity sells for £100 per share. In one year, Matt knows Air France’s shares will be trading at either £120 per share or £90 per share. Matt is able to borrow and lend at the risk-free EAR of 10 percent.
(a) What should the call option sell for today if using risk-neutral valuation?
(b) If no options currently trade on the equity, is there a way to create a synthetic call option with identical pay-offs to the call option just described? If there is, how would you do it?