Question

Suppose a European call option to buy a share for $22.50 costs $1.75. The stock currently trades for $20.00. If the option is held to maturity under what conditions does the holder of the option, make a profit? Note: ignore time value of money. How would the answer change if this was an American call option?

Please show work

Answer 1

European call option will only make profit when share price at the maturity will be increasing=

(Purchase price + call option premium)

= (22.5+1.75)= $24.25

European call option can only be excercised at maturity and when it will exceed 24.25, then only it will make profit.

If the the call option was an American call option then, call option could have been exercised before maturity and if before the maturity the market price had increased over 24.25, the American call option would have led to profit.