You have taken a long position in a call option on IBM common stock. The option

Question

You have taken a long position in a call option on IBM common stock. The option has an exercise price of $176 and IBM's stock currently trades at $180. The option premium is $5 per contract. How much of the option premium is due to intrinsic value versus time value? What is your net profit on the option if IBM's stock price increases to $190 at expiration of the option and you exercise the option? (Negative amount should be indicated by a minus sign.) What is your net profit if IBM's stock price decreases to $170? (Negative amount should be indicated by a minus sign.)

Explanation / Answer

a. Intrinsic value of option = Stock price - Strike price

= $180 - $176

= $4

Time value of option = Option premium - Intrinsic value

= $5 - $4

= $1

b. Net profit = Stock price - Strike price - Option premium

= $190 - $176 - $5

= $9

c. Net profit = Stock price - Strike price - Option premium

= $170 - $176 - $5

= -$11

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