The exercise price on one of ORNE Corporation's call options is $30 and the price of the underlying stock is $35. The option will expire in 25 days. The option is currently selling for $5.50.
a. Calculate the option's exercise value?
b. What is the value of the premium over and above the exercise value? What does this value represent?
c. Is this an out-of-the money option, at-the-money, or in-the-money? Why?
d. What will happen to the value of the option if the underlying stock price changes to $30? Why?
e. Is this an example of a covered call option or a naked call option? Why?
The exercise value of an option can be found as:
Max(0, S - K)
where S is the price of the underlying stock and K is the strike price of the option. In this case, S=35 and K=30, so S-K = 5. Since 5 is greater than 0, then the exercise value is $5.00
Since the option sells for $5.50 and the exercise value is $5.00, then the premium is $0.50. This premium represents the volatility of the stock price and the time left to expiration of the option. Usually ...
Discussion guides student through how to answer and gives solution with worded reasoning and displayed calculations. 371 words.