Question

You have taken a long position in a call option on IBM common stock. The option has an exercise price of $176 and IBM’s stock currently trades at $180. The option premium is $5 per contract. (LG 10-4)

How much of the option premium is due to intrinsic value versus time value?

page 350

What is your net profit on the option if IBM’s stock price increases to $190 at expiration of the option and you exercise the option?

What is your net profit if IBM’s stock price decreases to $170?

Answer 1

Exercise Price of Long Call - $ 180

Calculation of Option Premium Due to Intrinsic Value

Intrinsic Value = (Current Price - Exercise Price)

=$180-$176

= $ 4

Time value of option is i.e. =(Call premium - Intrinsic Value)

= $1 ($5-$4)

Net profit on the option if stock price increases to $190

If the IBM’s stock price increases to 190 $

Then i would like to exercise the call option and will buy the share at $176 giving me a Net profit of

= (Share price - Exercise Price) - Call Premium

=(190-176) - 5

= $ 9

If the IBM’s stock price is 170 $ then we would not the exercise the call option and will buy it from market at 170$ and the call option will lapse

There will be No Net profit if IBM’s stock price is 170$

However the call premium of 5$ would have been already paid so the cost will be 5$