Question

Suppose you purchased a two-month put option on 1,000 shares of a company’s stock with a strike price of $65/share.

a. The current market value of the stock is $70/share. What is the intrinsic value of your option?

b. In the first month, the maximum price of stock was $72/share and the minimum price of the stock was $68/share. For the first month, were you in the money, out of the money, or at the money?

c. In the second month, the stock price fell to $58/share. If you exercised the option at that point, how much was the option worth (for 1,000 shares)?

d. In this case, would you expect the time value on a two-month option to be greater than, less than, or equal to that of a one-month option?

Answer 1

X = 65

a) Intrinsic value of a put option = max(X - St, 0)

Intrinsic value = max(65 - 70, 0) = max(-5, 0)

Intrinsic value = 0

b) Put option is in the money if the market price of the stock is below its strike price. So, since the stock price was never below the strike price of $65, the put option was out of the money.

c) Put option value = max(X - St, 0)

Put option value = max(65 - 58,0)

Put option value = $7 per share

Total put option value = 7*1,000 = $7,000

d) Longer the time to expiry greater is the time-value of any option

So, the time value on a two-month option would be greater than that of a one-month option

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