Problem 1:

An investor purchase a call option when the price of stock is $60 and the exercise price of the option is $70 .what is the value of this option and why is that case? If the stock price move to $100 in the market at exercise date, and the premium is $5 .

Solution:

Intrinsic value represents the value that the buyer could extract from the option if he or she exercise the option immediately

Price if the option is execute immediately

Option value (a call option) = Exercise price (Xp) - Market price (Ps) - Premium

= (70 - 60 - 5) = $5

The Option is in the money (there is a financial advantage), it has an intrinsic value

If the stock price move to $90 in the market at exercise date, the gain that can be obtained:

Gain (a call option) = market price (MP) - exercise price (Xp) - premium

= (100 - 70 - 5) = $25

This case called in the money call option, because market price>exercise price (MP > Xp)