Question

For a public company, how is implied share price calculated? What complications does the existence of in-the-money options present?

Answer 1

Answer(1): Implied value per share tells the earning per share, that you expect to receive for each share, owned by you.

Implied value per share calculation- Steps are following:

1. First subtract all the expenditures (including depreciation, interest and tax) from revenue to get net profit.
2. Subtract preferred share dividend from Net Income.
3. Find out the number of common shares outstanding.
4. Divided Net Income by number of shares outstanding to get implied value of share.

Example: ABC company has $100000 Net Income and 50000 shares outstanding. Calculate Implied value of share?

Answer: Implied value of share = 100000 / 50000 = $2

Answer(2): In the money options-

Call option- When spot price is higher than strike price.

Put option- When strike price is higher than spot price.

An option which is ITM, has its intrinsic value. Intrinsic value is the different between the spot price and strike price (in case of call option).

Complications- In the money options are costlier to buy, premium of ITM options is higher than OTM and ATM. They tend to lose their value very frequently as the expiry comes nearer. They do not become zero at the time of expiry, they still have some value so writer of ITM option cannot let the option go, he has to exercise it and sometimes he suffers loss.