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Holder Ltd Purchased a Option Contract

Holder Ltd purchased a option contract for issuer Ltd that gave Holder Ltd the right to acquire 100,000 options in Torquay Ltd for a price (exercise price) of $10,000 per share. When the contract was exchanged, the price of Torquay Ltd shares were $9 each. The option entitles Holder Ltd to exercise the options and buy the shares anytime within the next six months. If the options are not exercised within the six month period, the options will expire.

Determine whether a financial liability or financial asset exists from the perspective of Holder Ltd and Issuer Ltd. Further, if the price of shares in Torquay Ltd falls to $5 (with the results that it is improbable that Holder Ltd will ever exercise the option) will this change the classification of the options as either financial assets or financial liabilities? Why?

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At purchase:

DEBIT: Call option......................$xx,xxx < -- price not given but whatever paid to get contract
CREDIT: Cash........................................$xx,xxx

These call options, that is, the contract that gives Holder Ltd the option, but not the obligation, to purchase shares of Torquay Ltd, is an asset that has two components, the time value plus the intrinsic value. The time value is what an investor would pay to have the right for a period of time. ...

Solution Summary

Your tutorials 279 words and a reference and explains how options (as opposed to forward contracts) work and why they are never a liability.