Given a stock price of $18, an exercise price of $20, and an interest rate of 7%, what are the intrinsic values which will occur for a one-period binomial option model if the stock price goes up to $23 or down to $16?
A) $3 and $0
B) $3 and −$4
C) $4 and $3
D) $4 and $2

Question

Quizplus · Accepted Answer

The intrinsic value of an option is the immediate exercise value of the option. For a call option, it is the maximum of zero or the difference between the stock price and the exercise price. If the stock price goes up to $23, the intrinsic value is $23 - $20 = $3. If the stock price goes down to $16, the intrinsic value is $0 because the option would not be exercised (as the exercise price is higher than the stock price).

Given a Stock Price of $18, an Exercise Price of $20