Question

Jackson Corporation stock is selling for $45 per share. An investor is considering buying a call option with an exercise price of $50. The investor is willing to pay the premium of 25 cents per option.

Please work in excel and show how you derived the answer.

A. Calculate the exercise value of the option?

B. Why is an investor willing to pay 50 cents an option when the stock is going for $45?

c. Calculate the exercise value if the price of the stock increases to $52 per share.

d. What is the difference between a put option and a call option?

e. If the exercise price for both the call option and the put option is $50, which will have a higher premium if the underlying stock price falls to $40 per share? Why?

Answer 1

A) The exercise value of an option is the profit than an option holder would receive by exercising the option. In our case when the stock price is less than the strike price of the option the call option is said to be out of money. Here current price of the stock is $45 while strike price is $50. The premium is 25 cents. Since $45<$50 the call option is out of money and hence the exercise value is $0.

B) The investor is willing to pay 50 cents altogether as the call option is out of money but the put option is in the money. For put option the strike price is $50 while the current price is $45. By exercising the put option the option holder can earn $5 which is the difference between Strike price and stock price. Subtracting the premuin the profit from exercising the put option is $4.50.

C) For call option the exercise value is $2 if stock price rises to $52. (Difference between Stock price and strike price)

For put option this is the case of out-of-money and the exercise value is $0.

D) Call option is an option for an investor when he/she speculates that the underlying price of the security will rise within a time frame.

Put option is an option for an investor when he/she speculates that the underlying price of the security will fall within a time frame.

E) If the stock price falls to $40 then the put option will ne more in-the-money option and hence it will command a higer premium. In this case it is better to exercise the put option and sell the asset at $50 rather than selling in the market which is stating $40. The investor wuill gain here.

For call option it is better to buy the shares directly from the market rather than having the option which entitles the option holder to buy the share at $50.