In CFAI vol 6, P123-Qu. 13-2nd part. It says it is correct. Plz explain if you can. (long question). Thanks
Paraphrased from CFAI text: The difference btwn market price of an option and its intrinsic value is its time value. Time value reflects potential for option’s intrinsic value at expiration to be greater than its current intrinsic value (at expiration, time value is zero). Remember that Option price = Intrinsic value + Time value. Also remember that intrinsic value for calls is Max (0,ST-X) and for puts is Max (0,X-ST). To address the question specifically, the underlying asset for both is priced at 55 (ST=55). Both are call options, so the intrinsic values are: for the 60 strike: Max (0,55-60) = 0 for the 50 strike: Max (0,55-50) = 5 Since for the 60, your intrinsic value is zero, you know the entire value of the option must be time value. For the 50, you have some intrinsic value, so a smaller proportion of that option’s value will be time value.
Thanks very much. I just wonder if I put more time to decifer this chapter or move along. It has such a little weight