Advanced financial management revision question and answer

Explain and illustrate graphically the options concepts of being:
i) “at the money”
ii) “in the money”
iii) “out of the money”
for both a call and put option.

ANSWER

b) Call option
A right to buy the underlying asset at the specified price (strike price) within a specified time.

Put option
Right to sell the underlying

Price = SP = “at the money”
For the holder of the call option “out of money” and “at the money” means that the option will be exercised and it will expire worthless.
The holder thus loses the option premium in this case. When the price of the underlying asset is greater than the strike price the option has value since the holder can buy the underlying asset at a price (strike price) below the assets current market price.


For the holder of the put option, “out of money” and “at the money” means that the option will not be exercised and it will be worthless. The owner thus loses the options premium. When the price of the underlying asset is less than the strike price, the option has value since the holder can sell the underlying asset at a price (strike price) higher than the assets current market price.

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