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You have taken a long position in a call option on IBM common stock. The option...

You have taken a long position in a call option on IBM common stock. The option has an exercise price of $150 and IBM's stock currently trades at $153. The option premium is $5 per contract.

a. How much of the option premium is due to intrinsic value versus time value?

b. What is your net profit on the option if IBM’s stock price increases to $163 at expiration of the option and you exercise the option?

c. What is your net profit if IBM’s stock price decreases to $143?

Solutions

Expert Solution

Answer(a): Intrinsic value - It is the value by which option is In-the money.

Intrinsic value = Spot price - Strike (Exercise) price

Intrinsic value = 153 - 150

Intrinsic value = $3

Time value of option = Option Premium - Intrinsic value

Time value of option = 5-3

Time value of option = 2

Answer(b): Call option- It is bought when market or a particular security is expected to go up. Profit from the call option is unlimited till the stock goes up. Upside is unlimited. Loss on call option is limited to the extent of premium paid.

Profit from Call option = (Current Spot price - Strike price of call option) - Premium paid

Profit from Call option = (163-150) - 5

Net Profit from Call option = $8

Answer(c): If IBM stock slips to $143 then there will be a loss as it goes below the strike price.

Net loss = (Spot price - Strike price + Premium)  

Net loss = (143 - 150 + 5 )

Net Loss = $12

jeff jeffy answered 1 year ago
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