Question

1. In the money, out of the money. 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

a) Intrisic value of put option = 0, because St > X (70 > 65)

b) In the first month, the put option was out of the money because the stock did not go below the strike price of $65

c) Put option value = max(X - St, 0) = max(65 - 58, 0) = 7

Total value = 7 * 1000 = $7,000

d) Longer the time to expiry the higher is the time value on any option.

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

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