Question

2. Suppose you purchase a put option to sell IBM common stock at $100 per share in September. The current price of IBM is $85 and the option premium is $10.

a. What is the intrinsic value of this option? As the expiration date on the option approaches, what will happen to the size of the option premium?

b. What would be in intrinsic value if this was a call option?

Answer #1

a) Strike price = $100

The Strike price is the price at which security can be purchased.

Market Price = $85

The intrinsic value of the option = Market Price - Strike Price

= 100 - 85

= $15

So the intrinsic value of the option is $15.

b) The size of option premium is $10. The Intrinsic value of the option is $15. As the expiration date on the option approaches, the size of the option premium which is $10 will approach the intrinsic value of the option which is $15.

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(LG 10-4)
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