An American-style call option with six months to maturity has a strike price of $35. The underlying stock now sells for $43. The call premium is $12.

a) What is the intrinsic value of the call?

b) What is the time value of the call?

c) If the company unexpectedly announces it will pay its first-ever dividend 3 months from today, you would expect that the value of the call would increase, decrease, or remain unchanged?

a) $8

b) $4

c) Decrease

Explanation:

Background.

A call option as you probably know, is an agreement to buy an asset on or before a particular day at a price already determined in the agreement.

a) the Intrinsic value of the option is the market price minus the strike price.

Intrinsic Value = Market Price - Strike price

= $43 - $35

= $8 per share.

It is worthy of note that for an option, of the intrinsic value dips into negative figures it is just said to be 0.

b) To calculate the time value, we subtract the intrinsic value from the call premium

= Call Premium - Intrinsic value

= $12 - $8

= $4

c) The call option has 6 months to maturity and the dividends are to come in 3 months. Share prices usually drop after a dividend has been paid so because the call option matures in 6 months, the price of the call option will DECREASE owing to the Expected drop in stock price.

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