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

Question

You have taken a long position in a call option on IBM common stock. The option has an exercise price of $143 and IBM's stock currently trades at $145. The option premium is $5 per contract.

a. How much of the option premium is due to intrinsic value versus time value? Option Premium Intrinsic value $ Time value

b. What is your net profit on the option if IBM’s stock price increases to $155 at expiration of the option and you exercise the option? (Negative amount should be indicated by a minus sign.) Net profit $ per share

c. What is your net profit if IBM’s stock price decreases to $135? (Negative amount should be indicated by a minus sign.) Net profit $ per share

Explanation / Answer

a)Intrinsic value of Opion = Current price -exercise price

              = 145 - 143

             = $ 2

Premium due to time value = 5 -2 = $3

b)Payoff ; Future spot price - Exercise price

           = 155- 143

       = $ 12

Net Profit = 12 -5 premium paid

          = $ 7

c)Option will not be exercies if future spot price falls to $ 135 as it is out of the money (that is you will not buy underlying that cost you $ 143 but currently selling at $ 135]

Net profit = $ -5 premium paid

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