LOS f: Define intrinsic value and time value, and explain their relationship.

Q1. A call option’s intrinsic value:

A)   decreases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price.

B)   increases as the stock price increases above the strike price, while a put option’s intrinsic value decreases as the stock price decreases below the strike price.

C)   increases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price.

Q2. The intrinsic value of an option is equal to:

A)   the amount that it is in or out of the money.

B)   zero or the amount that it is in the money.

C)   its speculative value.

Q3. Which of the following best describes the intrinsic value of an option? The intrinsic value is:

A)   highest if an option is at the money.

B)   its economic value if it is exercised immediately.

C)   its economic value if it is exercised at maturity.

Q4. Consider a call option on Intel with an exercise price of $25. The current stock price of Intel is $14. What is the intrinsic value of the call option?

A)   $0.

B)   $11.

C)   $25.

Q5. The price of a stock is $44 per share, and the October put with an exercise price of $45 is selling for $3. The intrinsic value of the option is:

A)   $1.00.

B)   $2.00.

C)   $0.00.

Correct answer is A)

Q6. An option’s intrinsic value is equal to the amount the option is:

A)   in the money, and the time value is the intrinsic value minus the market value.

B)   in the money, and the time value is the market value minus the intrinsic value.

C)   out of the money, and the time value is the market value minus the intrinsic value.

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Q1. A call option’s intrinsic value:

A)   decreases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price.

B)   increases as the stock price increases above the strike price, while a put option’s intrinsic value decreases as the stock price decreases below the strike price.

C)   increases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price.

Correct answer is C)

For a call option, as the underlying stock price increases above the strike price, the option moves farther into the money, and the intrinsic value is increasing. For a put option, as the underlying stock price decreases below the strike price, the option moves farther into the money, and the intrinsic value is increasing.

Q2. The intrinsic value of an option is equal to:

A)   the amount that it is in or out of the money.

B)   zero or the amount that it is in the money.

C)   its speculative value.

Correct answer is B)

The intrinsic value of an option is equal to the amount that it is in the money or zero, if it is out of the money. Intrinsic value equals speculative (time) value only for out-of-the-money options.

Q3. Which of the following best describes the intrinsic value of an option? The intrinsic value is:

A)   highest if an option is at the money.

B)   its economic value if it is exercised immediately.

C)   its economic value if it is exercised at maturity.

Correct answer is B)

The intrinsic value of an option is only positive if positive economic value results from exercising the option immediately.

Q4. Consider a call option on Intel with an exercise price of $25. The current stock price of Intel is $14. What is the intrinsic value of the call option?

A)   $0.

B)   $11.

C)   $25.

Correct answer is A)

The option has an intrinsic value of $0 because the stock price is below the exercise price. The call’s value is MAX (0, S ? X). Equivalently, the option is out-of-the-money.

Q5. The price of a stock is $44 per share, and the October put with an exercise price of $45 is selling for $3. The intrinsic value of the option is:

A)   $1.00.

B)   $2.00.

C)   $0.00.

Correct answer is A)

The intrinsic value of a put option at expiration will be the greater of (X-S) or 0. Put Value = max[0, (X-S)], or max [0, (45-44)] = 1.

Q6. An option’s intrinsic value is equal to the amount the option is:

A)   in the money, and the time value is the intrinsic value minus the market value.

B)   in the money, and the time value is the market value minus the intrinsic value.

C)   out of the money, and the time value is the market value minus the intrinsic value.

Correct answer is B)

Intrinsic value is the amount the option is in the money. In effect it is the value that would be realized if the option were at expiration. Prior to expiration, the option’s market value will normally exceed its intrinsic value. The difference between market value and intrinsic value is called time value.

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