Question

(i). You bought a call option on July 27, 2020 at the exercise price of $65. It expires on October 26, 2020. The stock currently sells for $66., while the call option sells for $6.

a) What is the intrinsic value of the call? What is the time premium paid for the call?

b) What will the value of this call be after expiration if the price of the stock is $99, $65, $99, and $80, respectively?

c) If the price of the stock rises to $80 at the expiration date of the call, what is the percentage increase in the value of the call? Does this example illustrate favorable leverage?

d) If an individual opens a covered call position on this stock, what is the net cost and what will the profit on the position be at the expiration of this position if the price of the stock is $49, $52, $59, $65, $66, $69, and $80, respectively?

e) If an individual sells this call naked, what will the profit or loss be on the position after six months if the price of the stock is $59, $66, and $80, respectively?

Answer 1

Ans a)

Call Strike Price X = 65

Spot Price S = 66

Intrinsic Value of the Call = Spot Price - Call Strike Price = 66 - 65 = 01

Call premium = $6

Time Value of the call = Call premium - Intrinsic Value of the Call = 6 - 1 = $ 5

Ans : Intrinsic Value of the Call = $ 1

Time Value of the call = $ 5

Ans b)

What will the value of this call be after expiration if the price of the stock

Value of call =Max( Expiration Price - Strike Price , 0)

value of this call at = $99	= 99 -65 = 34
value of this call at = $65	=65 - 65 = 0
value of this call at = $80	= 80 - 65 = 15

Ans c)

value of this call at = $80

= 80 - 65 = 15

Initial Purchase Price = $6

Percentage Increase = (Final Value - Initial Value) / Initial Value

= ( 15 - 6) / 6 = 150%

Increase in value equals to 150%

So it is an example of favourable leverage.

Ans d)

Covered Call Position

• Long Stock
• Short Call Option

Initial Price of Stock = 66

Expiration Price = E

Profit from Long Stock : E - 66

Call Premium received = $6

Call Strike Price X = 65

Loss from Shorting Call = Max ( E - 65, 0)

Total Profit = 6 - Max ( E -65, 0)

Means if expiration price goes below 65 call option will expire if price goes above 65 buyer will exercise the option.

Pay off at each expiration :

Expiration Price	Profit from Stock	Profit from Shorting Call	Total Profit
E =49	49 - 66 = -17	= 6	= -17+6 =-11
E =52	52 - 66 = -14	= 6	=-14 + 6 = -8
E =59	59-66 = -7	= 6	= -7 + 6 = -1
E = 65	65 - 66 = -1	=6	=-1 + 6 = 5
E=66	66 -66 = 0	=6 - (66-65) =05	=0+ 5 = 5
E= 69	69 -66 = 3	=6 - (69 -65) = 02	=3 + 2 = 5
E = 80	80 - 66 = 14	= 6 - (80 -65) = -9	=14 - 9 = 5

Ans e)

Call Premium received = $6

Call Strike Price X = 65

Loss from Shorting Call = Max ( E - 65, 0)

Total Profit = 6 - Max ( E - 65, 0)

At E = 66

Profit = 6 - (66 - 65) = 6 - 1 = 5

At E = 80

Profit = 6 - (80 - 65) = 6 - 15 = - 9