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13 August, 19:04

An American-style option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14.

a. If the company unexpectedly announces it will pay its first-ever dividend four months from today, you would expect that:

1. the call price would increase.

2. the call price would decrease.

3. the call/put price would not change.

4. the put price would decrease?

b. What is the intrinsic value of the call?

c. What is the time value of the call?

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Answers (1)
  1. 13 August, 19:16
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    (a) The call price would decrease (b) $8 per share (c) $6 per share

    Explanation:

    Solution:

    The Call option is the right to sell a specified security at a specified price on a future date.

    (a) The value of call option / price will decrease

    Since after payment of dividend, the market price of share will decrease

    Hence, value of call option will decrease

    (b) The Intrinsic Value = Market Price - Strike price

    = $50 - $42

    = $8 per share

    (c) The time Value = Option Premium - Intrinsic Value

    = 14-8

    = $6 per share
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