Question

An American-style option with six months to maturity has a strike price of $42. The underlying stock now sells for $50. The call premium is $14.
a. If the company unexpectedly announces it will pay its first-ever dividend four months from today, you would expect that:

1. the call price would increase.
2. the call price would decrease.
3. the call/put price would not change.
4. the put price would decrease?

b. What is the intrinsic value of the call?
c. What is the time value of the call?

Answer 1

Answer:

(a) The call price would decrease (b) $8 per share (c) $6 per share

Explanation:

Solution:

The Call option is the right to sell a specified security at a specified price on a future date.

(a) The value of call option/ price  will decrease

Since after payment of dividend, the market price of share will decrease

Hence, value of call option will decrease

(b)The Intrinsic Value = Market Price - Strike price

= $50 - $42

= $8 per share

(c)The time Value = Option Premium - Intrinsic Value

= 14-8

= $6 per share