Question

Assume that a stock is selling at a price of $100. The 95 call option on the stock sells for $5 and the 105 put option sells for $8.

What is the intrinsic and time value on the 95 call and $105 put?

If the stock increases to $110, what will be the dollar and percentage return on the call option. What will be the return on the put option?

Assume that the investor writes a call option on the above stock. What will be the investor’s gain or loss if the stock closed at $100?

Assume that the investor writes a put option on the above stock. What will be the gain or loss if the stock sells for $110?

Answer 1

Intrinsic value of call option = Stock price - Exercise Price

= 100 - 95

= 5 (As the right to buy is at 95 and stock price at $100 now, so profit, so Intrinsic value $5)

Intrinsic value of put option = Exercise Price - Stock Price

= 105 - 100

= $5 (As the right to sell is at 105 and stock price is at 100 now, so $5 profit)

If the stock price increases to 105, then the intrinsic value of call option will be increase to

= Stock price - Exercise Price

=110 - 95

= 10

So earlier the call price was $5 and it should increase by $5 now as the intrinsic value increased from $5 to $10.

So call price now is $10. Earlier it was $5. So 100% return.

In put option the exercise price is 105 and price in market is 105, so there is no value for the put option. Earlier the price of put option was $8 and now it is $0, so -100%

So if the investor writes a call option with strike price $95, and the stock closes at $100, then for the option writer the loss is

= Stock Price - Strike Price

= 100 - 95

= $5

And as he has already received $5 by selling the call, so for him no loss no profit.

So if an investor writes a put option at $105 and receives $8. And in the market the stock price moves to 110, so the option buyer will obviously want to sell the stock outside at $100 rather than at $105. So the the whole premium of $8 is the gain.