Question

Question 2. [Intrinsic Value of Options] Assume that S = Spot Price (on exercise date) and K = Strike Price. Provide your calculation and answers to the following steps. First step: compute the Intrinsic Value for each of the following option contracts: Cases (I), (II), (III), and (IV) below.

Second step: for each option contract below, discuss whether the option is: (A) In-the-Money; (B) At-the-Money; or (C) Out-of-Money.  Case (I) Call Option with S = 38 and K = 34  Case (II) Call Option with S = 150 and K = 175  Case (III) Put Option with S = 40 and K = 45  Case (IV) Put Option with S = 220 and K = 220

Answer 1

Intrinsic value of an Option is the value that a buyer of the option would get if the option was exercised today.

(i)

Call option

Spot Price, S = 38

Strike Price, K = 34

Intrinsic value of the call option = Spot price - Strike Price = 38-34 = 4

Intrinsic value of the call option = 4

A call option is In-the-Money if the Spot price is greater than Strike Price. This option is In-the-Money.

(ii)

Call option

Spot Price, S = 150

Strike Price, K = 175

Spot price - Strike Price = 150-175 = -25

Intrinsic value of an option can't be negative because if the market price is below strike price (in the case of call option) then the buyer would not exercise the option.

Hence the intrinsic value of this option is 0

A call option is Out-of-Money if the Spot price is greater than Strike Price. This option is Out-of-Money.

(iii)

Put option

Spot Price, S = 40

Strike Price, K = 45

Intrinsic value of the put option = Strike Price - Spot price = 45-40 = 5

Intrinsic value of the put option = 5

A put option is In-the-Money if the Strike price is greater than Spot Price. This option is In-the-Money.

(iv)

Put option

Spot Price, S = 220

Strike Price, K = 220

Intrinsic value of the put option = Strike Price - Spot price = 220-220 = 0

Intrinsic value of the put option = 0

A put option is At-the-Money if the Strike price is equal to Spot Price. This option is At-the-Money.