Question

The holder of a call option will not exercise its option when the spot price is lower than the strike before the contract mature and the holder of the put option will not exercise its option when the spot price is lower than the strike price before the contract mature.” Explain.

Answer 1

Call option gives the purchaser the right but not obligation to buy underlying asset to the contract and put option gives the purchaser the right but not obligation to sell underlying asset to the contract. Holder of option would therefore wait until the maturity of the contract to determine whether it should exercise or not the option. Call option holder would exercise the option if the strike price is lower than market value so it needs to pay lower and thus benefit from call option. Put option holder would exercise the option if strike price is higher than market price so it would receive higher amount and thus benefit from put option. The value of underlying security generally keep on varying and thus the option holder would wait till maturity period so that the transaction does not result in loss. If the spot price is lower than strike price then the shares is available at cheaper rate in the market and thus the call option holder would not exercise the option. Similarly for put option holder if strike price is lower than spot price then option would not be exercise. In both cases one would wait for the maturity of contract to determine whether option should be exercise or not.