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Answer on Economics of Enterprise Question for LaMarcus Streeter

Question #6209

2. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
b. Call options generally sell at a price less than their exercise value.
c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

Expert's answer

a. If
the underlying stock does not pay a dividend, it makes good economic sense to
exercise a call option as soon as the stock’s price exceeds the strike price by
about 10%, because this permits the option holder to lock in an immediate
profit.


In finance,
an
option is
a
derivative financial instrument that
specifies a contract between two parties for a future transaction on an asset at
a reference price (the strike).
[1]The
buyer of the option gains the right, but not the obligation, to engage in that
transaction, while the seller incurs the corresponding obligation to fulfil the
transaction. The price of an option derives from the difference between the
reference price and the value of the
underlying asset
(commonly a
stock,
a
bond,
a
currency or
a
futures contract)
plus a premium based on the time remaining until the expiration of the option.
Other types of options exist, and options can in principle be created for any
type of valuable asset.

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