Premium on Call Options
On April 30, 2009, the common stock of Minnesota Mining and Manufacturing ("3M") closed at a price of $57.60 per share. On that same date, the July 2009 $55 Calls on 3M common closed at a price of $4.90.
a) The premium on this in-the money Call can be understood in terms of two value components. Describe briefly and quantify these two components.
b) Assuming the stock price of 3M does not move for the remaining life of the Call, what would be expected to happen to each component of premium as the Expiration Date approaches?
For a call option intrinsic value = Max (0, S-X)
For a put option intrinsic value = Max (0, X-S)
where S = asset (stock) price and X = Strike (or Exercise) price
Time value of an option is the amount by which an option's total premium (price of the option) exceeds its intrinsic value.
Time value of an option arises due to the possibility that an option may increase in value as the price of the underlying asset changes (for a call option the asset price increases and for the put option the asset price decreases from current ...