March Lean Hogs are trading at 84 cents per pound. The total premium for an 80-c
ID: 2791299 • Letter: M
Question
March Lean Hogs are trading at 84 cents per pound. The total premium for an 80-cent call option is $3200. The contract size for Lean Hogs is 40,000 lbs.
a. What is the total intrinsic value of the option premium? What is the per pound intrinsic value of the premium?
b. What is the total extrinsic value of the option premium? What is the per pound extrinsic value of the premium?
2. You purchase a call option on July Crude Oil with a strike price of $42.50 per barrel. The premium on the option is $3.50 per barrel. July crude is currently trading a $41.35 per barrel and the contract size for crude oil is 1000 barrels. Give both the total premium and the premium per barrel for all answers.
a. What is the current intrinsic value of the option?
b. What is the current extrinsic value of the option?
c. Is the option In-the-Money, Out-of-the Money, or At-the-Money?
d. what price must July Crude reach for you to break even if you exercise the option?
e. If you exercise your option when July crude is trading at $44.75 per barrel, what is your profit or loss on the transaction?
f. The price of July Crude increases to $42.75 per barrel. At the same time the premium for a July Crude option increases to 3.90 per barrel. What is your profit or loss if you sell your option?
g. What is your profit or loss if the option expires Out-of-the-Money?
h. What would your maximum profit be if you had written the call option at a premium of $3.50 per barrel instead of purchasing it?
Explanation / Answer
Answer 1). a). Intrinsic Value of call option(Premium) = Spot Price - Strike Price
= (84-80) Cents per pound
= 4 Cents per pound
Total Intrinsic value of the option premium = Contract size * Intrinsic Value of call option premium per pound
= 40000*4 = 160000 Cents
b). Total Extrinsic Value of the option premium = Total Premium - Total Intrinsic Value
= (320000 - 160000) Cents
= 160000 Cents
Per Pound Extrinsic value = Total Extrinsic value / Contract Size
= 160000 / 40000 = 4 Cent per Pound
Answer 2). a). Current intrinsic value of the call option = Spot price - Strike price
= $41.35 - $42.50 = -$1.15 , Intrinsic value can not be negative. So it will be take as Zero.
Per Barrel current intrinsic value = Zero
b). Current Extrinsic value Total = Total Premium value - Intrinsic Value
= 3.50 * 1000 - 0
= $3500
Per barrel extrinsic value = 3500 / 1000 = $3.50
c). Spot price is lower than to the strike price. So it is a situation of out of the Money.
d). Break even = Strike Price + Premium
= $42.50 + $3.50
= $46 per barrel
Total break even = $46 * 1000
= $46000
e). Profit / (Loss) = Exercise Price - Strike price - Premium
= $44.75 - $41.50 - $3.50
= ($1.25) per barrel
Total loss = $1.25 * 1000 = $1250
f). Profit on increase of premium = 3.90 - 3.50 = $0.40 per barrel
Total profit = $0.40 * 1000 = $400
g). If option expired out of the money, then only premium money lost.
Per barrrel loss = $3.50
Total Loss = $3.50 * 1000 = $3500
h). If written the call option then maxium profit possible in call is = Premium amount
Per barrel profit = $3.50
Total profit = $3.50 * 1000
= $3500