Question

The value of a call option can never exceed...(please explain)

a. zero.

b. the difference between the underlying stock price and the option’s exercise price.

c. the option's exercise price.

d. the underlying stock price.

Compared to a European option, the value of an otherwise identical American option is...(please explain)

a. sometimes less, and never greater.

b. always equal to the value of the European option.

c.sometimes greater, and never less.

d. always greater.

e. always less.

It is never rational to exercise an American ____ option on a ___________ stock prior to its expiration date.(please explain)

a. call ... dividend-paying

b. put ... non-dividend-paying

c. call ... non-dividend-paying

d. put ... dividend-paying

Answer 1

(1) The value of a call option is composed of two parts, namely the intrinsic value and the time value. The latter decreases as an option approaches maturity and becomes zero at maturity. The intrinsic value is equal to the difference between the underlying stock price and the call option's strike price. The value of a call option almost always exceeds zero, is more than the difference between the stock price and exercise price before maturity owing to the option's time value and can definitely exceed its exercise price. For example an option with an exercise price of $ 9 and a stock price of $30 has intrinsic value equal to (30-9) = $ 21 which is more than the option's exercise price. However, an option's value will never exceed the underlying stock price as the same forms the upper limit of the option's intrinsic value.

Hence, the correct option is (d).

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.