Problem 3:

A call option has an exercise price of $60, and the current price of the underlying stock is $70. Originally, the buyer of this call paid a $3 premium to purchase the call.

1- How much profit will this investor make if the call contract is exercise?

2- If the market price of the stock became $75 at exercise date, Does the investor execute the option contract

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

1- Option value (a call option) = Current market price (Ps) - exercise price (Xp) - premium

= 70-60-3 = $7

this investor will profit 7 dollar for each stock he bought.

2- In this case, market price(75)>exercise price (60), the gain that can be obtained:

Gain = 75-60-3= $12, this call option is in the money -should be execute