You currently own a one-year call option on Way-One, Inc. stock. The current stock price is $26.50 and the risk-free rate of return is 4 percent. Your option has a strike price of $20 and you assume that it will finish in the money. What is the current value of your call option?
A) $6.25
B) $6.50
C) $6.76
D) $7.13
E) $7.27

Question

Quizplus · Accepted Answer

The current value of the call option can be approximated using the Black-Scholes model or a similar option pricing model. However, without applying a specific model and given the information, a basic approach to estimate the intrinsic value (the difference between the stock price and the strike price, for an in-the-money call option) can be used. The intrinsic value is $26.50 - $20 = $6.50. However, since the option is expected to finish in the money and there's a positive risk-free rate, its value must also include the time value, which accounts for the potential additional gain due to the risk-free rate of return. Therefore, the correct answer must be higher than the intrinsic value of $6.50, making E) $7.27 the best choice among the given options. This choice accounts for both the intrinsic value and the time value, considering the risk-free rate of return.

You Currently Own a One-Year Call Option on Way-One, Inc