Exercise Value & Price
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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?
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Solution Summary
Discussion guides student through how to answer and gives solution with worded reasoning and displayed calculations. 371 words.
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Question A
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
Question B
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 ...
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