Question

A put option on a non-dividend-paying stock is priced at $5.50. The strike price of the put option is $55. When current stock price is $60, this put option has an intrinsic value of ( ) and a time value of ( )

a. $5.50, $0

b. $5.00, $5.50

c. $5.50 , $5.00

d. $0, $5.50

Answer 1

Solution

The answer is d. $0, $5.50 from parts (i) and (ii) of the explanations below:

Intrinsic value of a put option is the exces of the strike price over the price of the underlying stock. To put it simply, the strike price is the price at which you would 'put' or exercise your right to sell the underlying stock at the strike price provided the stock price is lower than the strike price. This would mean a profit of the excess of strike price of the option over the underlying stock price. Otherwise, if the stock price is higher than the option strike price the right to 'put' would not not be exercised and would lapse at expiration and you would sell the stock at its current market price (since that would be higher). So the intrinsic value of the put option = Strike price - Stock price (if strike price > stock price) and 0 (if strike price < stock price)

Here the strike price $55 is lower than stock price of $60. So do not exercise the put, let it lapse and the intrinsic value is 0. ........(i)

Option premium is the amount paid upfront to buy the option contract. In this case the price is $5.50

Option premium is the sum of intrinsic value and time value

Option premium = Time value + Intrinsic value   

So, Time value = Premium - Intrinsic value   

Time value = $5.50 - 0

= $5.50 ..........(ii)