Question 1. (10 points) The exercise price on one of ORNE Corporation\'s call op

Question

Question 1. (10 points) The exercise price on one of ORNE Corporation's call options is $25 and the price of the underlying stock is $30. The option will expire in 30 days and is currently selling at $5.50.

a. Calculate the option's exercise value? What is the significance of this value?

b. Why is an investor willing to pay more than the exercise value for the option?

c. If the price of the underlying stock changes to $32 per share, will the market value of the option increase, decrease, or remain the same? Why

d. If Orne Corporation had issued a put option (instead of the call), would its value increase, decrease, or remain the same if the price of the underlying stock increased? Why?

Explanation / Answer

a. Exercise Value = Current price of the stock - Exercise price of the stock

= $30 - $25 = $5

b. The investor is willing to pay more than the worth ,because riskier the asset and its expected return, pricier the option value. If the investor expects the share price to rise further and he can buy it at a cheaper rate using a call option, he will be ready to pay more.

c. Market value of option = $32- $25 = $7

The value of option will increase if the underlying stock price increased since the investor will get it at a cheaper price in spite of increase in the value of the stock.

d. Put option refers to selling the shares for a higher agreed rate when the stock prices fall. The value of option will decrease if the underlying stock price increased since the investor will have to selling at a agreed rate of $25 in spite of the stock price increasing to $32.

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