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?

(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