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Premium on Call Options

On April 30, 2009, the common stock of Minnesota Mining and Manufacturing ("3M") closed at a price of $57.60 per share. On that same date, the July 2009 $55 Calls on 3M common closed at a price of $4.90.

a) The premium on this in-the money Call can be understood in terms of two value components. Describe briefly and quantify these two components.
b) Assuming the stock price of 3M does not move for the remaining life of the Call, what would be expected to happen to each component of premium as the Expiration Date approaches?

Solution Preview

Please see the attached file:

On April 30, 2009, the common stock of Minnesota Mining and Manufacturing ("3M") closed at a price of $57.60 per share.  On that same date, the July 2009 $55 Calls on 3M common closed at a price of $4.90.

a) the premium on this in-the money Call can be understood in terms of two value components.  Describe briefly and quantify these two components.

Option premium = Intrinsic value + Speculative premium (time value)

Intrinsic value is the maximum of 0 and the value it would have if it were to be exercised ...

Solution Summary

The expert finds the values of the two components of call option premium.

$2.19