Fall 2010 Class 4

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Unformatted text preview: a preset (strike or exercise) price purchase – Put Option • Holder has the right to sell at a preset price Holder right sell – Written Option • An option is a written one for the firm issues the An written issues option and receives a premium option – Purchased Option • An option is a purchased one for the firm buys An purchased buys the option and pay a premium the Accounting for Option Accounting for Option Example: A purchase call option: • Firm A spend $400 to buy a call option from Firm B on Firm January 2, 2004 January • The option gives Firm A the right to buy from Firm B The Firm Firm 1,000 shares of Firm C’s common shares at $100 per Firm share share • Option will expire on April 30, 2004 • Market price of Firm C’s shares on January 2, 2004 is Market Firm $100 per share $100 • Share price increased to $120 on March 31 and on Share April 1 • The options are trading at $20,100 on March 31. • On April 1, Firm A settle the options with Firm B. On Firm Firm Accounting for Option Accounting for Option Option Price Formula Option Intrinsic = Premium Value Market Price less Strike (Exercise) Price Option Premium + Time Value Option Value Less Intrinsic Value = ($100 - $100) + ($400 - $0) Option Price Option Price Date Jan. 2 Mar. 31 April. 1 Intrinsic Value Gain/Loss Time Value Gain/Loss Option Value $0 $400 $400 $20,000 $20,000 $100 -$300 $20,100 $20,000 $0 $0 -$100 $20,100 Total Gain= $19,600 =$20,000-...
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