Suppose you buy and have (long) “a $50 June Microsoft call” for $5.00. Which of

Question

Suppose you buy and have (long) “a $50 June Microsoft call” for $5.00. Which of the following statements is incorrect?

A. This is a buying option with a strike price of $50 expiring in June and the underlying asset is the common stock of Microsoft.

B. You have the right to buy the common stock of Microsoft at $50 until the expiration date in June regardless of the actual price of the stock.

C. If the current price of Microsoft stock is $45, this call is in the money.

D. If you have a “corresponding” put option, you have the right to sell the stock.

Explanation / Answer

"If the current price of Microsoft stock is $45, this call is in the money" is incorrect.

In the money means that the call will be exercised and give a positive payoff. As rightly pointed out in option B that going long on a call gives the long party a right to purchase the stock at the predefined strike price no matter what the actual price is.

Any rational investor would exercise this right only when he gets a positive pay off i.e. if he can buy the stock at low price and sell it at high price. Therefore the stock price should be higher than the strike of 50 for the option to be in the money and worth exercising. As 45 < 50 therefore this option is out of the money and statement C is incorrect.

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