Answer to Question #12660 in Management for John

Question

3. Which of the following statements is CORRECT?
a. An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
c. Issuing options provides companies with a low cost method of raising capital.
d. The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

Answer 1

The CORRECT statement is D. Option valuation is any procedure for assigning a market value to an option. The market value of the option is determined by auction selling on the Options Exchange. Price, which is suitable for the buyer and seller of an option, is called the premium. The premium includes two main elements: the intrinsic value and time value. Intrinsic value reflects the amount, if any, to which the option is "in the money.". An option to the date of expiry of the contract has no time value, and the premium includes only intrinsic value. The greatest value of the time value of options is usually observed "in the money." As soon as the option moves further "in the money" or "no money", the time value component of a premium progressively decreases. Time value diminishes as the expiration date of the contract is coming, and the rate of decay increases.