Question

A trader buys a 1M European call option on a share. The stock price is £108 and the strike price is £97.

1)What is the intrinsic value of this option?

2)How would the intrinsic value change if this were a 9M option?

3) Will this option be exercised at maturity? Why or why not?

4)What is time value and how does it change the price of an option?

Answer 1

1) Intrinsic value is the difference between the stock price and the strike price

i.e 108-97 = 11M Pounds.

2) Intrinsic value if there are 9M option = 11pounds *9= 99M Pounds.

3) Since the strike price is less than the stock price, the option will be exercised at maturity as the trader can buy at less rate of pound 97 by exercising the call option instead buying it at a higher rate of pound 108 in the market.

4) An option's time value is equal to its premium (the cost of the option) minus its intrinsic value (the difference between the strike price and the price of the underlying). As a general rule, the more time that remains until expiration, the greater the time value of the option.

Note: Since cost of the option i.e premium is not available in the question, intrinsic value can not be findout.