Question

Suppose you bought an American call option two weeks ago and paid a premium of $5. You look at your account now and see that the option is in-the-money and has two weeks remaining until expiry. Summarize all the possible decisions that you could make right now with respect to this option position. Provide as much detail as possible regarding the mechanics of your decision (i.e. how you would implement the decision and what would happen as a result).

Answer 1

I have paid a premium of $5. The call is in the money, suppose the strike price is $50 the stock price is $55. Now, the option is in the money, but the pay off is zero and the holder of the call option still suffers a loss of -$5.

So, even if the option is in the money, he should exercise the option and wait till the option matures, which has 2 more weeks to ago, After which if the stock price rises further the option holder may exercise the option at that time.

Now, suppose if the stock price is $70. and the strike price is $50, the option holder may exercise the option as it is in the money, and thus profiting also from the position. The profit is ($70 -$55- $5 = $10)

The pay off of an option is = ( strike price- stock price)

profit/loss is = (pay off - option premium)