Question

Suppose you believe that the price of Stock X is going to increase from its current level of $18 during the next several months. For $4 you buy a call option giving you the right to buy 1 share at a price of $24 per share.

a. What is the exercise value of the option now?

b. What is the time value of the option?

c. Calculate the net profit (dollars) if the option is purchased and the stock price rises to $30?

Answer 1

a. The call option gives us the right to buy 1 share at a price of $24. Hence, strike price or exercise price of the option = $24

Since, (Exercise price of call > Current Market Price), exercise value of the option at present = 0

b.

Since, currently (exercise price of call > Current Market Price), the entire price is composed of time value or extrinsic value.

Hence, time value or extrinsic value of option = 4

c.

If Stock Price increases to 30, Net Profit or Pay-off at expiration = (30 - 24) = $6

The Option was Purchased for $4

Hence, Net Profit = $6 - $4 = $2