Question

Jackson Corporation stock is selling for $45 per share. An investor is considering buying a call option with an exercise price of $50. The investor is willing to pay the premium of 55 cents per option. Please work in excel and show how you derived the answer.

A. Calculate the exercise value of the option?

B. Why is an investor willing to pay 50 cents an option when the stock is going for $45?

c. Calculate the exercise value if the price of the stock increases to $52 per share.

d.  What is the difference between a put option and a call option?

e.  If the exercise price for both the call option and the put option is $50, which will have a higher premium if the underlying stock price falls to $40 per share?  Why?

Answer 1

a]

Exercise value of call option = higher of zero, and (stock price - exercise price)

Exercise value of call option = higher of zero, and ($45 - $50).

Exercise value of call option = zero

b]

The investor is willing to pay 55 cents for the option to buy the stock at $50. In case the stock price at expiry is more than $50, the investor can exercise the option to buy the stock at $50. The premium is paid to buy this option. Although the stock is currently at $50, there is a chance that the stock price at the expiry of option is more than $50. In such a case, the option would be valuable. Hence, the premium of 55 cents is paid to avail this option

c]

Exercise value of call option = higher of zero, and (stock price - exercise price)

Exercise value of call option = higher of zero, and ($45 - $52).

Exercise value of call option = zero

d]

A put option is an option to sell the underlying asset at a specified exercise price. A call option is an option to buy the underlying asset at a specified exercise price.