Sam Is Considering Purchasing a Call Option on ABC Stock

question 26

Multiple Choice

Sam is considering purchasing a call option on ABC stock. The call has a premium of $3, an exercise price of $50, and ABC is trading at $51 per share. Which of the following statements about the call option is correct?

• A) The call has an intrinsic value of $1 and a time value of $2.
• B) The call has an intrinsic value of $0 and a time value of $3.
• C) The call has an intrinsic value of $3 and a time value of $2.
• D) The call has an intrinsic value of $0 and a time value of $1.

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Definitions:

Present Value

The current value of a future sum of money or stream of cash flows, discounted at a specified rate of return.

At-the-money

A term used in options trading to describe a situation where the option's strike price is identical to the current market price of the underlying asset.

Call Option

A financial contract that gives the buyer the right but not the obligation to buy a stock, bond, commodity, or other asset at a specified price within a specific time period.

Dynamic Hedging

A strategy of managing risk that involves adjusting the number of derivatives used as financial instruments in proportion to the changing value of the underlying asset.